10-Q 1 d249880d10q.htm FORM 10-Q Form 10-Q
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

or

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                             to

  

Commission File Number: 001-14965

The Goldman Sachs Group, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   13-4019460

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

200 West Street, New York, N.Y.   10282
(Address of principal executive offices)   (Zip Code)

(212) 902-1000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer  x                     Accelerated filer  ¨
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)         Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨ Yes x No

APPLICABLE ONLY TO CORPORATE ISSUERS

As of October 21, 2016, there were 397,649,217 shares of the registrant’s common stock outstanding.

 


Table of Contents

THE GOLDMAN SACHS GROUP, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2016

 

INDEX

 

Form 10-Q Item Number    Page No.
 

PART I

 

FINANCIAL INFORMATION

   2
 

Item 1

 

Financial Statements (Unaudited)

   2
 
 

Condensed Consolidated Statements of Earnings for the three and nine months ended September 30, 2016 and September 30, 2015

   2
 
 

Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2016 and September 30, 2015

   3
 
 

Condensed Consolidated Statements of Financial Condition as of September 30, 2016 and December 31, 2015

   4
 
 

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2016 and year ended December 31, 2015

   5
 
 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and September 30, 2015

   6
 
 

Notes to Condensed Consolidated Financial Statements

   7
 
 

Note 1.         Description of Business

   7
 
 

Note 2.         Basis of Presentation

   7
 
 

Note 3.         Significant Accounting Policies

   8
 
 

Note 4.         Financial Instruments Owned, at Fair Value and Financial Instruments Sold,

  
 

                     But Not Yet Purchased, at Fair Value

   14
 
 

Note 5.         Fair Value Measurements

   15
 
 

Note 6.         Cash Instruments

   16
 
 

Note 7.         Derivatives and Hedging Activities

   24
 
 

Note 8.         Fair Value Option

   36
 
 

Note 9.         Loans Receivable

   43
 
 

Note 10.       Collateralized Agreements and Financings

   47
 
 

Note 11.       Securitization Activities

   51
 
 

Note 12.       Variable Interest Entities

   53
 
 

Note 13.      Other Assets

   57
 
 

Note 14.      Deposits

   59
 
 

Note 15.      Short-Term Borrowings

   60
 
 

Note 16.      Long-Term Borrowings

   60
 
 

Note 17.       Other Liabilities and Accrued Expenses

   63
 
 

Note 18.       Commitments, Contingencies and Guarantees

   63
 
 

Note 19.       Shareholders’ Equity

   68
 
 

Note 20.       Regulation and Capital Adequacy

   70
 
 

Note 21.       Earnings Per Common Share

   79
 
 

Note 22.       Transactions with Affiliated Funds

   79
 
 

Note 23.       Interest Income and Interest Expense

   80
 
 

Note 24.      Income Taxes

   81
 
 

Note 25.      Business Segments

   82
 
 

Note 26.      Credit Concentrations

   84
 
 

Note 27.      Legal Proceedings

   85
 
 

Report of Independent Registered Public Accounting Firm

   93
 
 

Statistical Disclosures

   94
 

Item 2

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   96
 

Item 3

 

Quantitative and Qualitative Disclosures About Market Risk

   161
 

Item 4

 

Controls and Procedures

   161
 

PART II

 

OTHER INFORMATION

   161
 

Item 1

 

Legal Proceedings

   161
 

Item 2

 

Unregistered Sales of Equity Securities and Use of Proceeds

   162
 

Item 6

 

Exhibits

   162
 

SIGNATURES

   163

 

    Goldman Sachs September 2016 Form 10-Q   1


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings

(Unaudited)

 

   

Three Months

Ended September

       

Nine Months

Ended September

 
in millions, except per share amounts     2016         2015            2016         2015   

Revenues

           

Investment banking

    $1,537         $1,556          $  4,787         $  5,480   
   

Investment management

    1,386         1,331          3,908         4,400   
   

Commissions and fees

    753         859          2,447         2,517   
   

Market making

    2,715         1,730          7,067         7,964   
   

Other principal transactions

    1,163         543            1,978         3,822   

Total non-interest revenues

    7,554         6,019          20,187         24,183   
   

 

Interest income

    2,389         2,119          7,267         6,304   
   

Interest expense

    1,775         1,277            5,016         3,940   

Net interest income

    614         842            2,251         2,364   

Net revenues, including net interest income

    8,168         6,861            22,438         26,547   

 

Operating expenses

           

Compensation and benefits

    3,207         2,351          9,200         10,619   
   

 

Brokerage, clearing, exchange and distribution fees

    613         665          1,929         1,950   
   

Market development

    92         123          326         409   
   

Communications and technology

    207         200          609         601   
   

Depreciation and amortization

    247         222          731         706   
   

Occupancy

    245         182          609         572   
   

Professional fees

    222         253          673         714   
   

Other expenses

    467         819            1,454         3,270   

Total non-compensation expenses

    2,093         2,464            6,331         8,222   

Total operating expenses

    5,300         4,815            15,531         18,841   

 

Pre-tax earnings

    2,868         2,046          6,907         7,706   
   

Provision for taxes

    774         620            1,856         2,388   

Net earnings

    2,094         1,426          5,051         5,318   
   

Preferred stock dividends

    (6      96            117         324   

Net earnings applicable to common shareholders

    $2,100         $1,330            $  4,934         $  4,994   

 

Earnings per common share

           

Basic

    $  4.96         $  2.95          $  11.40         $  11.03   
   

Diluted

    4.88         2.90          11.24         10.84   
   

 

Dividends declared per common share

    $  0.65         $  0.65          $    1.95         $    1.90   
   

 

Average common shares

           

Basic

    422.4         449.0          431.5         451.2   
   

Diluted

    430.2         458.6            438.8         460.9   

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

2   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

    Three Months
Ended September
       

Nine Months

Ended September

 
$ in millions     2016         2015            2016         2015   

Net earnings

    $2,094         $1,426          $5,051         $5,318   
   

Other comprehensive income/(loss) adjustments, net of tax:

           

Currency translation

    (19      (39       (58      (94
   

Debt valuation adjustment

    (13               (75        
   

Pension and postretirement liabilities

    1         36            (36      (74

Other comprehensive loss

    (31      (3         (169      (168

Comprehensive income

    $2,063         $1,423            $4,882         $5,150   

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

    Goldman Sachs September 2016 Form 10-Q   3


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Financial Condition

(Unaudited)

 

    As of  
$ in millions, except per share amounts    
 
September
2016
  
  
    
 
December
2015
  
  

Assets

    

Cash and cash equivalents

    $  99,535         $  75,105   
   

Cash and securities segregated for regulatory and other purposes (includes $36,058 and $38,504 at fair value as of September 2016 and December 2015, respectively)

    54,526         56,838   
   

Collateralized agreements:

    

Securities purchased under agreements to resell and federal funds sold (includes $93,352 and $119,450 at fair value as of September 2016 and December 2015, respectively)

    94,220         120,905   
   

Securities borrowed (includes $78,788 and $69,801 at fair value as of September 2016 and December 2015, respectively)

    185,468         172,099   
   

Receivables:

    

Brokers, dealers and clearing organizations

    25,681         25,453   
   

Customers and counterparties (includes $3,297 and $4,992 at fair value as of September 2016 and December 2015, respectively)

    53,855         46,430   
   

Loans receivable

    49,064         45,407   
   

Financial instruments owned, at fair value (includes $55,800 and $54,426 pledged as collateral as of September 2016 and December 2015, respectively)

    292,420         293,940   
   

Other assets

    25,218         25,218   

Total assets

    $879,987         $861,395   

 

Liabilities and shareholders’ equity

    

Deposits (includes $14,096 and $14,680 at fair value as of September 2016 and December 2015, respectively)

    $124,550         $  97,519   
   

Collateralized financings:

    

Securities sold under agreements to repurchase, at fair value

    73,905         86,069   
   

Securities loaned (includes $1,969 and $466 at fair value as of September 2016 and December 2015, respectively)

    5,256         3,614   
   

Other secured financings (includes $22,006 and $23,207 at fair value as of September 2016 and December 2015, respectively)

    22,478         24,753   
   

Payables:

    

Brokers, dealers and clearing organizations

    8,862         5,406   
   

Customers and counterparties

    195,625         204,956   
   

Financial instruments sold, but not yet purchased, at fair value

    115,154         115,248   
   

Unsecured short-term borrowings, including the current portion of unsecured long-term borrowings (includes $16,741 and $17,743 at fair value as of September 2016 and December 2015, respectively)

    42,825         42,787   
   

Unsecured long-term borrowings (includes $30,266 and $22,273 at fair value as of September 2016 and December 2015, respectively)

    190,586         175,422   
   

Other liabilities and accrued expenses (includes $665 and $1,253 at fair value as of September 2016 and December 2015, respectively)

    13,636         18,893   

Total liabilities

    792,877         774,667   
   

 

Commitments, contingencies and guarantees

    

 

Shareholders’ equity

    

Preferred stock, par value $0.01 per share; aggregate liquidation preference of $11,203 and $11,200 as of September 2016 and December 2015, respectively

    11,203         11,200   
   

Common stock, par value $0.01 per share; 4,000,000,000 shares authorized, 872,612,590 and 863,976,731 shares issued as of September 2016 and December 2015, respectively, and 399,211,902 and 419,480,736 shares outstanding as of September 2016 and December 2015, respectively

    9         9   
   

Share-based awards

    3,974         4,151   
   

Nonvoting common stock, par value $0.01 per share; 200,000,000 shares authorized, no shares issued and outstanding

              
   

Additional paid-in capital

    52,541         51,340   
   

Retained earnings

    87,160         83,386   
   

Accumulated other comprehensive loss

    (582      (718
   

Stock held in treasury, at cost, par value $0.01 per share; 473,400,690 and 444,495,997 shares as of September 2016 and December 2015, respectively

    (67,195      (62,640

Total shareholders’ equity

    87,110         86,728   

Total liabilities and shareholders’ equity

    $879,987         $861,395   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

$ in millions    

 

Nine Months Ended

September 2016

  

  

    

 

Year Ended

December 2015

  

  

Preferred stock

    

Balance, beginning of year

    $ 11,200         $   9,200   
   

Issued

    1,325         2,000   
   

Redeemed

    (1,322        

Balance, end of period

    11,203         11,200   
   

Common stock

    

Balance, beginning of year

    9         9   
   

Issued

              

Balance, end of period

    9         9   
   

Share-based awards

    

Balance, beginning of year

    4,151         3,766   
   

Issuance and amortization of share-based awards

    1,981         2,308   
   

Delivery of common stock underlying share-based awards

    (2,065      (1,742
   

Forfeiture of share-based awards

    (80      (72
   

Exercise of share-based awards

    (13      (109

Balance, end of period

    3,974         4,151   
   

Additional paid-in capital

    

Balance, beginning of year

    51,340         50,049   
   

Delivery of common stock underlying share-based awards

    2,077         2,092   
   

Cancellation of share-based awards in satisfaction of withholding tax requirements

    (954      (1,198
   

Preferred stock issuance costs, net

    (10      (7
   

Excess net tax benefit related to share-based awards

    88         406   
   

Cash settlement of share-based awards

            (2

Balance, end of period

    52,541         51,340   
   

Retained earnings

    

Balance, beginning of year, as previously reported

    83,386         78,984   
   

Reclassification of cumulative debt valuation adjustment, net of tax, to accumulated other comprehensive loss

    (305        

Balance, beginning of year, adjusted

    83,081         78,984   
   

Net earnings

    5,051         6,083   
   

Dividends and dividend equivalents declared on common stock and share-based awards

    (855      (1,166
   

Dividends declared on preferred stock

    (383      (515
   

Preferred stock redemption discount

    266           

Balance, end of period

    87,160         83,386   
   

Accumulated other comprehensive loss

    

Balance, beginning of year, as previously reported

    (718      (743
   

Reclassification of cumulative debt valuation adjustment, net of tax, from retained earnings

    305           

Balance, beginning of year, adjusted

    (413      (743
   

Other comprehensive income/(loss)

    (169      25   

Balance, end of period

    (582      (718
   

Stock held in treasury, at cost

    

Balance, beginning of year

    (62,640      (58,468
   

Repurchased

    (4,569      (4,195
   

Reissued

    21         32   
   

Other

    (7      (9

Balance, end of period

    (67,195      (62,640

Total shareholders’ equity

    $ 87,110         $ 86,728   

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

    Goldman Sachs September 2016 Form 10-Q   5


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

   

Nine Months

Ended September

 
$ in millions     2016         2015   

Cash flows from operating activities

    

Net earnings

    $   5,051         $   5,318   
   

Adjustments to reconcile net earnings to net cash provided by/(used for) operating activities

    

Depreciation and amortization

    731         706   
   

Share-based compensation

    1,943         2,107   
   

Gain related to extinguishment of junior subordinated debt

            (34
   

Changes in operating assets and liabilities

    

Cash and securities segregated for regulatory and other purposes

    2,312         (6,452
   

Receivables and payables (excluding loans receivable), net

    (13,524      4,524   
   

Collateralized transactions (excluding other secured financings), net

    2,794         (12,902
   

Financial instruments owned, at fair value

    5,386         18,366   
   

Financial instruments sold, but not yet purchased, at fair value

    (29      (6,753
   

Other, net

    (2,891      (4,714

Net cash provided by operating activities

    1,773         166   
   

Cash flows from investing activities

    

Purchase of property, leasehold improvements and equipment

    (2,063      (1,205
   

Proceeds from sales of property, leasehold improvements and equipment

    332         120   
   

Net cash acquired in/(used for) business acquisitions

    15,754         (1,684
   

Proceeds from sales of investments

    1,209         714   
   

Loans receivable, net

    (3,930      (12,692

Net cash provided by/(used for) investing activities

    11,302         (14,747
   

Cash flows from financing activities

    

Unsecured short-term borrowings, net

    140         (1,228
   

Other secured financings (short-term), net

    395         (492
   

Proceeds from issuance of other secured financings (long-term)

    2,377         10,772   
   

Repayment of other secured financings (long-term), including the current portion

    (6,486      (7,360
   

Purchase of APEX, senior guaranteed securities and trust preferred securities

    (1,171      (1
   

Proceeds from issuance of unsecured long-term borrowings

    39,134         36,031   
   

Repayment of unsecured long-term borrowings, including the current portion

    (29,198      (22,513
   

Derivative contracts with a financing element, net

    81         (89
   

Deposits, net

    10,510         8,578   
   

Common stock repurchased

    (4,590      (2,545
   

Dividends and dividend equivalents paid on common stock, preferred stock and share-based awards

    (1,238      (1,197
   

Proceeds from issuance of preferred stock, net of issuance costs

    1,303         1,993   
   

Proceeds from issuance of common stock, including exercise of share-based awards

    1         220   
   

Excess tax benefit related to share-based awards

    97         388   
   

Cash settlement of share-based awards

            (1

Net cash provided by financing activities

    11,355         22,556   

Net increase in cash and cash equivalents

    24,430         7,975   
   

Cash and cash equivalents, beginning of year

    75,105         57,600   

Cash and cash equivalents, end of period

    $ 99,535         $ 65,575   

SUPPLEMENTAL DISCLOSURES:

Cash payments for interest, net of capitalized interest, were $5.40 billion and $4.09 billion, and cash payments for income taxes, net of refunds, were $767 million and $2.20 billion during the nine months ended September 2016 and September 2015, respectively.

Non-cash activities during the nine months ended September 2016:

 

 

The impact of adoption of ASU No. 2015-02 was a net reduction to both total assets and liabilities of approximately $200 million. See Note 3 for further information.

 

 

The firm sold assets and liabilities of $1.81 billion and $697 million, respectively, that were previously classified as held for sale, in exchange for $1.11 billion of financial instruments. See Notes 13 and 17 for further information.

 

 

The firm exchanged $1.04 billion of APEX for $1.31 billion of Series E and Series F Preferred Stock. See Note 19 for further information.

 

 

Cash flows related to common stock repurchased includes common stock repurchased in the prior period for which settlement occurred during the current period and excludes common stock repurchased during the current period for which settlement occurred in the following period.

Non-cash activities during the nine months ended September 2015:

 

 

The firm exchanged $262 million of Trust Preferred Securities and common beneficial interests for $296 million of certain of the firm’s junior subordinated debt.

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1.

Description of Business

The Goldman Sachs Group, Inc. (Group Inc. or parent company), a Delaware corporation, together with its consolidated subsidiaries (collectively, the firm), is a leading global investment banking, securities and investment management firm that provides a wide range of financial services to a substantial and diversified client base that includes corporations, financial institutions, governments and individuals. Founded in 1869, the firm is headquartered in New York and maintains offices in all major financial centers around the world.

The firm reports its activities in the following four business segments:

Investment Banking

The firm provides a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds and governments. Services include strategic advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, restructurings, spin-offs and risk management, and debt and equity underwriting of public offerings and private placements, including local and cross-border transactions and acquisition financing, as well as derivative transactions directly related to these activities.

Institutional Client Services

The firm facilitates client transactions and makes markets in fixed income, equity, currency and commodity products, primarily with institutional clients such as corporations, financial institutions, investment funds and governments. The firm also makes markets in and clears client transactions on major stock, options and futures exchanges worldwide and provides financing, securities lending and other prime brokerage services to institutional clients.

Investing & Lending

The firm invests in and originates loans to provide financing to clients. These investments and loans are typically longer-term in nature. The firm makes investments, some of which are consolidated, directly and indirectly through funds and separate accounts that the firm manages, in debt securities and loans, public and private equity securities, and real estate entities.

Investment Management

The firm provides investment management services and offers investment products (primarily through separately managed accounts and commingled vehicles, such as mutual funds and private investment funds) across all major asset classes to a diverse set of institutional and individual clients. The firm also offers wealth advisory services, including portfolio management and financial counseling, and brokerage and other transaction services to high-net-worth individuals and families.

Note 2.

Basis of Presentation

These condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and include the accounts of Group Inc. and all other entities in which the firm has a controlling financial interest. Intercompany transactions and balances have been eliminated.

These condensed consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements included in the firm’s Annual Report on Form 10-K for the year ended December 31, 2015. References to “the 2015 Form 10-K” are to the firm’s Annual Report on Form 10-K for the year ended December 31, 2015. The condensed consolidated financial information as of December 31, 2015 has been derived from audited consolidated financial statements not included in these financial statements.

These unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. These adjustments are of a normal, recurring nature. Interim period operating results may not be indicative of the operating results for a full year.

All references to September 2016, June 2016 and September 2015 refer to the firm’s periods ended, or the dates, as the context requires, September 30, 2016, June 30, 2016 and September 30, 2015, respectively. All references to December 2015 refer to the date December 31, 2015. Any reference to a future year refers to a year ending on December 31 of that year. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.

 

 

    Goldman Sachs September 2016 Form 10-Q   7


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 3.

Significant Accounting Policies

 

The firm’s significant accounting policies include when and how to measure the fair value of assets and liabilities, accounting for goodwill and identifiable intangible assets, and when to consolidate an entity. See Notes 5 through 8 for policies on fair value measurements, Note 13 for policies on goodwill and identifiable intangible assets, and below and Note 12 for policies on consolidation accounting. All other significant accounting policies are either described below or included in the following footnotes:

 

Financial Instruments Owned, at Fair Value and Financial

Instruments Sold, But Not Yet Purchased, at Fair Value

    Note 4   

Fair Value Measurements

    Note 5   

Cash Instruments

    Note 6   

Derivatives and Hedging Activities

    Note 7   

Fair Value Option

    Note 8   

Loans Receivable

    Note 9   

Collateralized Agreements and Financings

    Note 10   

Securitization Activities

    Note 11   

Variable Interest Entities

    Note 12   

Other Assets

    Note 13   

Deposits

    Note 14   

Short-Term Borrowings

    Note 15   

Long-Term Borrowings

    Note 16   

Other Liabilities and Accrued Expenses

    Note 17   

Commitments, Contingencies and Guarantees

    Note 18   

Shareholders’ Equity

    Note 19   

Regulation and Capital Adequacy

    Note 20   

Earnings Per Common Share

    Note 21   

Transactions with Affiliated Funds

    Note 22   

Interest Income and Interest Expense

    Note 23   

Income Taxes

    Note 24   

Business Segments

    Note 25   

Credit Concentrations

    Note 26   

Legal Proceedings

    Note 27   

Consolidation

The firm consolidates entities in which the firm has a controlling financial interest. The firm determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity (VIE).

Voting Interest Entities. Voting interest entities are entities in which (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity. The usual condition for a controlling financial interest in a voting interest entity is ownership of a majority voting interest. If the firm has a controlling majority voting interest in a voting interest entity, the entity is consolidated.

Variable Interest Entities. A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. The firm has a controlling financial interest in a VIE when the firm has a variable interest or interests that provide it with (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. See Note 12 for further information about VIEs.

Equity-Method Investments. When the firm does not have a controlling financial interest in an entity but can exert significant influence over the entity’s operating and financial policies, the investment is accounted for either (i) under the equity method of accounting or (ii) at fair value by electing the fair value option available under U.S. GAAP. Significant influence generally exists when the firm owns 20% to 50% of the entity’s common stock or in-substance common stock.

In general, the firm accounts for investments acquired after the fair value option became available, at fair value. In certain cases, the firm applies the equity method of accounting to new investments that are strategic in nature or closely related to the firm’s principal business activities, when the firm has a significant degree of involvement in the cash flows or operations of the investee or when cost-benefit considerations are less significant. See Note 13 for further information about equity-method investments.

 

 

8   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Investment Funds. The firm has formed numerous investment funds with third-party investors. These funds are typically organized as limited partnerships or limited liability companies for which the firm acts as general partner or manager. Generally, the firm does not hold a majority of the economic interests in these funds. These funds are usually voting interest entities and generally are not consolidated because third-party investors typically have rights to terminate the funds or to remove the firm as general partner or manager. Investments in these funds are generally measured at net asset value (NAV) and are included in “Financial instruments owned, at fair value.” See Notes 6, 18 and 22 for further information about investments in funds.

Use of Estimates

Preparation of these condensed consolidated financial statements requires management to make certain estimates and assumptions, the most important of which relate to fair value measurements, accounting for goodwill and identifiable intangible assets, discretionary compensation accruals, the provisions for losses that may arise from litigation, regulatory proceedings and tax audits, and the allowance for losses on loans and lending commitments held for investment. These estimates and assumptions are based on the best available information but actual results could be materially different.

Revenue Recognition

Financial Assets and Financial Liabilities at Fair Value. Financial instruments owned, at fair value and Financial instruments sold, but not yet purchased, at fair value are recorded at fair value either under the fair value option or in accordance with other U.S. GAAP. In addition, the firm has elected to account for certain of its other financial assets and financial liabilities at fair value by electing the fair value option. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. Fair value gains or losses are generally included in “Market making” for positions in Institutional Client Services and “Other principal transactions” for positions in Investing & Lending. See Notes 5 through 8 for further information about fair value measurements.

Investment Banking. Fees from financial advisory assignments and underwriting revenues are recognized in earnings when the services related to the underlying transaction are completed under the terms of the assignment. Expenses associated with such transactions are deferred until the related revenue is recognized or the assignment is otherwise concluded. Expenses associated with financial advisory assignments are recorded as non-compensation expenses, net of client reimbursements. Underwriting revenues are presented net of related expenses.

Investment Management. The firm earns management fees and incentive fees for investment management services. Management fees for mutual funds are calculated as a percentage of daily net asset value and are received monthly. Management fees for hedge funds and separately managed accounts are calculated as a percentage of month-end net asset value and are generally received quarterly. Management fees for private equity funds are calculated as a percentage of monthly invested capital or commitments and are received quarterly, semi-annually or annually, depending on the fund. All management fees are recognized over the period that the related service is provided. Incentive fees are calculated as a percentage of a fund’s or separately managed account’s return, or excess return above a specified benchmark or other performance target. Incentive fees are generally based on investment performance over a 12-month period or over the life of a fund. Fees that are based on performance over a 12-month period are subject to adjustment prior to the end of the measurement period. For fees that are based on investment performance over the life of the fund, future investment underperformance may require fees previously distributed to the firm to be returned to the fund. Incentive fees are recognized only when all material contingencies have been resolved. Management and incentive fee revenues are included in “Investment management” revenues.

The firm makes payments to brokers and advisors related to the placement of the firm’s investment funds. These payments are calculated based on either a percentage of the management fee or the investment fund’s net asset value. Where the firm is principal to the arrangement, such costs are recorded on a gross basis and included in “Brokerage, clearing, exchange and distribution fees,” and where the firm is agent to the arrangement, such costs are recorded on a net basis in “Investment management” revenues.

 

 

    Goldman Sachs September 2016 Form 10-Q   9


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Commissions and Fees. The firm earns “Commissions and fees” from executing and clearing client transactions on stock, options and futures markets, as well as over-the-counter (OTC) transactions. Commissions and fees are recognized on the day the trade is executed.

Transfers of Assets

Transfers of assets are accounted for as sales when the firm has relinquished control over the assets transferred. For transfers of assets accounted for as sales, any gains or losses are recognized in net revenues. Assets or liabilities that arise from the firm’s continuing involvement with transferred assets are initially recognized at fair value. For transfers of assets that are not accounted for as sales, the assets generally remain in “Financial instruments owned, at fair value” and the transfer is accounted for as a collateralized financing, with the related interest expense recognized over the life of the transaction. See Note 10 for further information about transfers of assets accounted for as collateralized financings and Note 11 for further information about transfers of assets accounted for as sales.

Cash and Cash Equivalents

The firm defines cash equivalents as highly liquid overnight deposits held in the ordinary course of business. As of September 2016 and December 2015, “Cash and cash equivalents” included $6.85 billion and $6.47 billion, respectively, of cash and due from banks, and $92.69 billion and $68.64 billion, respectively, of interest-bearing deposits with banks.

Receivables from and Payables to Brokers, Dealers and Clearing Organizations

Receivables from and payables to brokers, dealers and clearing organizations are accounted for at cost plus accrued interest, which generally approximates fair value. While these receivables and payables are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6 through 8. Had these receivables and payables been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of September 2016 and December 2015.

Receivables from Customers and Counterparties

Receivables from customers and counterparties generally relate to collateralized transactions. Such receivables are primarily comprised of customer margin loans, certain transfers of assets accounted for as secured loans rather than purchases at fair value and collateral posted in connection with certain derivative transactions. Substantially all of these receivables are accounted for at amortized cost net of estimated uncollectible amounts. Certain of the firm’s receivables from customers and counterparties are accounted for at fair value under the fair value option, with changes in fair value generally included in “Market making” revenues. See Note 8 for further information about receivables from customers and counterparties accounted for at fair value under the fair value option. In addition, as of September 2016 and December 2015, the firm’s receivables from customers and counterparties included $3.12 billion and $2.35 billion, respectively, of loans held for sale, accounted for at the lower of cost or fair value. See Note 5 for an overview of the firm’s fair value measurement policies.

As of September 2016 and December 2015, the carrying value of receivables not accounted for at fair value generally approximated fair value. While these items are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6 through 8. Had these items been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of September 2016 and December 2015. Interest on receivables from customers and counterparties is recognized over the life of the transaction and included in “Interest income.”

Payables to Customers and Counterparties

Payables to customers and counterparties primarily consist of customer credit balances related to the firm’s prime brokerage activities. Payables to customers and counterparties are accounted for at cost plus accrued interest, which generally approximates fair value. While these payables are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6 through 8. Had these payables been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of September 2016 and December 2015. Interest on payables to customers and counterparties is recognized over the life of the transaction and included in “Interest expense.”

 

 

10   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Offsetting Assets and Liabilities

To reduce credit exposures on derivatives and securities financing transactions, the firm may enter into master netting agreements or similar arrangements (collectively, netting agreements) with counterparties that permit it to offset receivables and payables with such counterparties. A netting agreement is a contract with a counterparty that permits net settlement of multiple transactions with that counterparty, including upon the exercise of termination rights by a non-defaulting party. Upon exercise of such termination rights, all transactions governed by the netting agreement are terminated and a net settlement amount is calculated. In addition, the firm receives and posts cash and securities collateral with respect to its derivatives and securities financing transactions, subject to the terms of the related credit support agreements or similar arrangements (collectively, credit support agreements). An enforceable credit support agreement grants the non-defaulting party exercising termination rights the right to liquidate the collateral and apply the proceeds to any amounts owed. In order to assess enforceability of the firm’s right of setoff under netting and credit support agreements, the firm evaluates various factors including applicable bankruptcy laws, local statutes and regulatory provisions in the jurisdiction of the parties to the agreement.

Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) in the condensed consolidated statements of financial condition when a legal right of setoff exists under an enforceable netting agreement. Resale and repurchase agreements and securities borrowed and loaned transactions with the same term and currency are presented on a net-by-counterparty basis in the condensed consolidated statements of financial condition when such transactions meet certain settlement criteria and are subject to netting agreements.

In the condensed consolidated statements of financial condition, derivatives are reported net of cash collateral received and posted under enforceable credit support agreements, when transacted under an enforceable netting agreement. In the condensed consolidated statements of financial condition, resale and repurchase agreements, and securities borrowed and loaned, are not reported net of the related cash and securities received or posted as collateral. See Note 10 for further information about collateral received and pledged, including rights to deliver or repledge collateral. See Notes 7 and 10 for further information about offsetting.

Share-based Compensation

The cost of employee services received in exchange for a share-based award is generally measured based on the grant-date fair value of the award. Share-based awards that do not require future service (i.e., vested awards, including awards granted to retirement-eligible employees) are expensed immediately. Share-based awards that require future service are amortized over the relevant service period. Expected forfeitures are included in determining share-based employee compensation expense.

The firm pays cash dividend equivalents on outstanding restricted stock units (RSUs). Dividend equivalents paid on RSUs are generally charged to retained earnings. Dividend equivalents paid on RSUs expected to be forfeited are included in compensation expense. The firm accounts for the tax benefit related to dividend equivalents paid on RSUs as an increase to additional paid-in capital.

The firm generally issues new shares of common stock upon delivery of share-based awards. In certain cases, primarily related to conflicted employment (as outlined in the applicable award agreements), the firm may cash settle share-based compensation awards accounted for as equity instruments. For these awards, whose terms allow for cash settlement, additional paid-in capital is adjusted to the extent of the difference between the value of the award at the time of cash settlement and the grant-date value of the award.

Foreign Currency Translation

Assets and liabilities denominated in non-U.S. currencies are translated at rates of exchange prevailing on the date of the condensed consolidated statements of financial condition and revenues and expenses are translated at average rates of exchange for the period. Foreign currency remeasurement gains or losses on transactions in nonfunctional currencies are recognized in earnings. Gains or losses on translation of the financial statements of a non-U.S. operation, when the functional currency is other than the U.S. dollar, are included, net of hedges and taxes, in the condensed consolidated statements of comprehensive income.

 

 

    Goldman Sachs September 2016 Form 10-Q   11


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Recent Accounting Developments

Revenue from Contracts with Customers (ASC 606). In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU No. 2014-09 provides comprehensive guidance on the recognition of revenue from customers arising from the transfer of goods and services. The ASU also provides guidance on accounting for certain contract costs, and requires new disclosures. ASU No. 2014-09, as amended by ASU No. 2015-14, ASU No. 2016-08, ASU No. 2016-10 and ASU No. 2016-12, is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period under a modified retrospective approach or retrospectively to all periods presented. Early adoption is permitted for annual reporting periods beginning after December 15, 2016. The firm is still evaluating the effect of the ASU on its financial condition, results of operations, and cash flows.

Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (ASC 810). In August 2014, the FASB issued ASU No. 2014-13, “Consolidation (Topic 810) — Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (CFE).” ASU No. 2014-13 provides an alternative to reflect changes in the fair value of the financial assets and the financial liabilities of the CFE by measuring either the fair value of the assets or liabilities, whichever is more observable. ASU No. 2014-13 provides new disclosure requirements for those electing this approach, and was effective for interim and annual periods beginning after December 15, 2015. Adoption of ASU No. 2014-13 did not materially affect the firm’s financial condition, results of operations, or cash flows.

Amendments to the Consolidation Analysis (ASC 810). In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810) — Amendments to the Consolidation Analysis.” ASU No. 2015-02 eliminates the deferral of the requirements of ASU No. 2009-17, “Consolidations (Topic 810) — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” for certain interests in investment funds and provides a scope exception from Topic 810 for certain investments in money market funds. The ASU also makes several modifications to the consolidation guidance for VIEs and general partners’ investments in limited partnerships, as well as modifications to the evaluation of whether limited partnerships are VIEs or voting interest entities. ASU No. 2015-02 was effective for interim and annual reporting periods beginning after December 15, 2015 and was required to be adopted under a modified retrospective approach or retrospectively to all periods presented.

The firm adopted ASU No. 2015-02 as of January 1, 2016, using a modified retrospective approach. The impact of adoption was a net reduction to both total assets and total liabilities of approximately $200 million, substantially all included in “Financial instruments owned, at fair value” and in “Other liabilities and accrued expenses,” respectively. Adoption of ASU No. 2015-02 did not have an impact on the firm’s results of operations. See Note 12 for further information about the adoption of ASU No. 2015-02.

Simplifying the Presentation of Debt Issuance Costs (ASC 835). In April 2015, the FASB issued ASU No. 2015-03, “Interest — Imputation of Interest (Subtopic 835-30) — Simplifying the Presentation of Debt Issuance Costs.” ASU No. 2015-03 simplifies the presentation of debt issuance costs by requiring that these costs related to a recognized debt liability be presented in the statements of financial condition as a direct reduction from the carrying amount of that liability. ASU No. 2015-03 was effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. ASU No. 2015-03 was required to be applied retrospectively to all periods presented beginning in the year of adoption. Early adoption was permitted. The firm early adopted ASU No. 2015-03 in September 2015.

Improvements to Employee Share-Based Payment Accounting (ASC 718). In March 2016, the FASB issued ASU No. 2016-09, “Compensation — Stock Compensation (Topic 718) — Improvements to Employee Share-Based Payment Accounting.” ASU No. 2016-09 includes provisions to simplify certain aspects related to the accounting for share-based awards and the related financial statement presentation. This ASU includes a requirement that the tax effect related to the settlement of share-based awards be recorded in income tax benefit or expense in the statements of earnings. This change is required to be adopted prospectively in the period of adoption. In addition, the ASU modifies the classification of certain share-based payment activities within the statements of cash flows and these changes are generally required to be applied retrospectively to all periods presented beginning in the period of adoption. ASU No. 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is permitted. The impact of ASU No. 2016-09 could be material to the firm’s results of operations and cash flows in future periods depending upon, among other things, the level of earnings and stock price of the firm.

 

 

12   Goldman Sachs September 2016 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Simplifying the Accounting for Measurement-Period Adjustments (ASC 805). In September 2015, the FASB issued ASU No. 2015-16, “Business Combinations (Topic 805) — Simplifying the Accounting for Measurement-Period Adjustments.” ASU No. 2015-16 eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. ASU No. 2015-16 was effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. Adoption of ASU No. 2015-16 did not materially affect the firm’s financial condition, results of operations, or cash flows.

Recognition and Measurement of Financial Assets and Financial Liabilities (ASC 825). In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments (Topic 825) — Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU No. 2016-01 amends certain aspects of recognition, measurement, presentation and disclosure of financial instruments. This guidance includes a requirement to present separately in other comprehensive income changes in fair value attributable to a firm’s own credit spreads (debt valuation adjustment or DVA), net of tax, on financial liabilities for which the fair value option was elected. ASU No. 2016-01 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted under a modified retrospective approach for the requirements related to DVA. In the first quarter of 2016, the firm early adopted ASU No. 2016-01 for the requirements related to DVA, and reclassified the cumulative DVA, a gain of $305 million (net of tax), from retained earnings to accumulated other comprehensive loss.

Leases (ASC 842). In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” ASU No. 2016-02 requires that, at lease inception, a lessee recognize in the statements of financial condition a right-of-use asset, representing the right to use the underlying asset for the lease term, and a lease liability, representing the liability to make lease payments. The ASU also requires that for finance leases, a lessee recognize interest expense on the lease liability, separately from the amortization of the right-of-use asset in the statements of earnings, while for operating leases, such amounts should be recognized as a combined expense in the statements of earnings. In addition, ASU No. 2016-02 requires expanded disclosures about the nature and terms of lease agreements and is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period under a modified retrospective approach. Early adoption is permitted. The firm is still evaluating the effect of the ASU on its financial condition, results of operations, and cash flows.

Measurement of Credit Losses on Financial Instruments (ASC 326). In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments — Credit Losses (Topic 326) — Measurement of Credit Losses on Financial Instruments.” ASU No. 2016-13 requires financial assets that are measured at amortized cost to be presented, net of an allowance for credit losses, at the amount expected to be collected over their estimated life. Expected credit losses for newly recognized financial assets, as well as changes to credit losses during the period, are recognized in earnings. For certain purchased financial assets with deterioration in credit quality since origination, the initial allowance for expected credit losses will be recorded as an increase to the purchase price. Expected credit losses, including losses on off-balance-sheet exposures such as lending commitments, will be measured based on historical experience, current conditions and forecasts that affect the collectability of the reported amount. ASU No. 2016-13 is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period under a modified retrospective approach. Early adoption is permitted for periods beginning after December 15, 2018. The firm is still evaluating the effect of the ASU on its financial condition, results of operations, and cash flows.

Classification of Certain Cash Receipts and Cash Payments (ASC 230). In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230) — Classification of Certain Cash Receipts and Cash Payments.” ASU No. 2016-15 provides guidance on the disclosure and classification of certain items within the statement of cash flows, including beneficial interests obtained in a securitization of financial assets, cash payments for settlements of zero-coupon debt instruments and debt prepayment or extinguishment costs, and distributions received from equity-method investees. ASU No. 2016-15 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and is required to be applied retrospectively to all periods presented beginning in the year of adoption. Early adoption is permitted. Since the ASU only impacts classification on the statements of cash flows, adoption will not affect the firm’s cash and cash equivalents.

 

 

    Goldman Sachs September 2016 Form 10-Q   13


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 4.

 

Financial Instruments Owned, at Fair Value and Financial Instruments Sold, But Not Yet Purchased, at Fair Value

    

 

Financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value are accounted for at fair value either under the fair value option or in accordance with other U.S. GAAP. See Note 8 for further information about other financial assets and financial liabilities accounted for at fair value primarily under the fair value option.

The table below presents the firm’s financial instruments owned, at fair value, and financial instruments sold, but not yet purchased, at fair value.

 

$ in millions    

 

 

Financial

Instruments

Owned

  

  

  

   

 

 

 

 

Financial

Instruments

Sold, But

Not Yet

Purchased

  

  

  

  

  

As of September 2016

   

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $    2,463        $          —   
   

U.S. government and federal agency obligations

    45,306        14,751   
   

Non-U.S. government and agency obligations

    38,036        19,589   
   

Loans and securities backed by:

   

Commercial real estate

    4,523        6   
   

Residential real estate

    9,411          
   

Bank loans and bridge loans

    9,859        468   
   

Corporate debt securities

    21,128        6,313   
   

State and municipal obligations

    1,705          
   

Other debt obligations

    1,163        2   
   

Equities and convertible debentures

    91,280        29,586   
   

Commodities

    5,943          
   

Investments in funds at NAV

    6,859          

Subtotal

    237,676        70,715   
   

Derivatives

    54,744        44,439   

Total

    $292,420        $115,154   

 

As of December 2015

   

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $    2,583        $          —   
   

U.S. government and federal agency obligations

    46,382        15,516   
   

Non-U.S. government and agency obligations

    31,772        14,973   
   

Loans and securities backed by:

   

Commercial real estate

    4,975        4   
   

Residential real estate

    13,183        2   
   

Bank loans and bridge loans

    12,164        461   
   

Corporate debt securities

    16,640        6,123   
   

State and municipal obligations

    992        2   
   

Other debt obligations

    1,595        2   
   

Equities and convertible debentures

    98,072        31,394   
   

Commodities

    3,935          
   

Investments in funds at NAV

    7,757          

Subtotal

    240,050        68,477   
   

Derivatives

    53,890        46,771   

Total

    $293,940        $115,248   

Gains and Losses from Market Making and Other Principal Transactions

The table below presents “Market making” revenues by major product type, as well as “Other principal transactions” revenues.

 

   

Three Months

Ended September

       

Nine Months

Ended September

 
$ in millions     2016         2015            2016         2015   

Product Type

           

Interest rates

    $   821         $  (132       $1,091         $     146   
   

Credit

    440         298          1,688         1,218   
   

Currencies

    544         (656       1,254         1,135   
   

Equities

    663         1,968          2,215         4,671   
   

Commodities

    247         252            819         794   

Market making

    2,715         1,730            7,067         7,964   

Other principal transactions

    1,163         543            1,978         3,822   

Total

    $3,878         $2,273            $9,045         $11,786   

In the table above:

 

 

Gains/(losses) include both realized and unrealized gains and losses, and are primarily related to the firm’s financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value, including both derivative and non-derivative financial instruments.

 

 

Gains/(losses) exclude related interest income and interest expense. See Note 23 for further information about interest income and interest expense.

 

 

Gains/(losses) on other principal transactions are included in the firm’s Investing & Lending segment. See Note 25 for net revenues, including net interest income, by product type for Investing & Lending, as well as the amount of net interest income included in Investing & Lending.

 

 

Gains/(losses) are not representative of the manner in which the firm manages its business activities because many of the firm’s market-making and client facilitation strategies utilize financial instruments across various product types. Accordingly, gains or losses in one product type frequently offset gains or losses in other product types. For example, most of the firm’s longer-term derivatives across product types are sensitive to changes in interest rates and may be economically hedged with interest rate swaps. Similarly, a significant portion of the firm’s cash instruments and derivatives across product types has exposure to foreign currencies and may be economically hedged with foreign currency contracts.

 

 

14   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 5.

Fair Value Measurements

 

The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. The firm measures certain financial assets and financial liabilities as a portfolio (i.e., based on its net exposure to market and/or credit risks).

The best evidence of fair value is a quoted price in an active market. If quoted prices in active markets are not available, fair value is determined by reference to prices for similar instruments, quoted prices or recent transactions in less active markets, or internally developed models that primarily use market-based or independently sourced parameters as inputs including, but not limited to, interest rates, volatilities, equity or debt prices, foreign exchange rates, commodity prices, credit spreads and funding spreads (i.e., the spread, or difference, between the interest rate at which a borrower could finance a given financial instrument relative to a benchmark interest rate).

U.S. GAAP has a three-level fair value hierarchy for disclosure of fair value measurements. The fair value hierarchy prioritizes inputs to the valuation techniques used to measure fair value, giving the highest priority to level 1 inputs and the lowest priority to level 3 inputs. A financial instrument’s level in the fair value hierarchy is based on the lowest level of input that is significant to its fair value measurement. The fair value hierarchy is as follows:

Level 1. Inputs are unadjusted quoted prices in active markets to which the firm had access at the measurement date for identical, unrestricted assets or liabilities.

Level 2. Inputs to valuation techniques are observable, either directly or indirectly.

Level 3. One or more inputs to valuation techniques are significant and unobservable.

The fair values for substantially all of the firm’s financial assets and financial liabilities are based on observable prices and inputs and are classified in levels 1 and 2 of the fair value hierarchy. Certain level 2 and level 3 financial assets and financial liabilities may require appropriate valuation adjustments that a market participant would require to arrive at fair value for factors such as counterparty and the firm’s credit quality, funding risk, transfer restrictions, liquidity and bid/offer spreads. Valuation adjustments are generally based on market evidence.

See Notes 6 through 8 for further information about fair value measurements of cash instruments, derivatives and other financial assets and financial liabilities accounted for at fair value primarily under the fair value option (including information about unrealized gains and losses related to level 3 financial assets and financial liabilities, and transfers in and out of level 3), respectively.

The table below presents financial assets and financial liabilities accounted for at fair value under the fair value option or in accordance with other U.S. GAAP. Counterparty and cash collateral netting represents the impact on derivatives of netting across levels of the fair value hierarchy. Netting among positions classified in the same level is included in that level.

 

    As of  
$ in millions    

 

September

2016

  

  

   

 

June

2016

  

  

   

 

December

2015

 

  

Total level 1 financial assets

    $ 146,775        $ 129,627        $153,051   
   

Total level 2 financial assets

    426,203        451,127        432,445   
   

Total level 3 financial assets

    24,289        24,732        24,046   
   

Investments in funds at NAV

    6,859        7,008        7,757   
   

Counterparty and cash collateral netting

    (100,211     (102,715     (90,612

Total financial assets at fair value

    $ 503,915        $ 509,779        $526,687   

Total assets

    $ 879,987        $ 896,843        $861,395   
   

Total level 3 financial assets divided by:

     

Total assets

    2.8%        2.8%        2.8%   
   

Total financial assets at fair value

    4.8%        4.9%        4.6%   

Total level 1 financial liabilities

    $   62,631        $   62,841        $  59,798   
   

Total level 2 financial liabilities

    243,800        256,973        245,759   
   

Total level 3 financial liabilities

    19,021        19,335        16,812   
   

Counterparty and cash collateral netting

    (50,650     (51,496     (41,430

Total financial liabilities at fair value

    $ 274,802        $ 287,653        $280,939   

Total level 3 financial liabilities divided by:

     

Total financial liabilities at fair value

    6.9%        6.7%        6.0%   

In the table above, Total assets includes $855 billion, $872 billion and $836 billion as of September 2016, June 2016 and December 2015, respectively, that is carried at fair value or at amounts that generally approximate fair value.

The table below presents a summary of level 3 financial assets.

 

    As of  
$ in millions    

 

September

2016

  

  

   

 

June

2016

  

  

   

 

December

2015

  

  

Cash instruments

    $   18,141        $   18,131        $  18,131   
   

Derivatives

    6,093        6,553        5,870   
   

Other financial assets

    55        48        45   

Total

    $   24,289        $   24,732        $  24,046   

Level 3 financial assets as of September 2016 were essentially unchanged compared with June 2016 and December 2015. See Notes 6 through 8 for further information about level 3 financial assets.

 

 

    Goldman Sachs September 2016 Form 10-Q   15


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6.

Cash Instruments

 

Cash instruments include U.S. government and federal agency obligations, non-U.S. government and agency obligations, mortgage-backed loans and securities, bank loans and bridge loans, corporate debt securities, equities and convertible debentures, investments in funds at NAV, and other non-derivative financial instruments owned and financial instruments sold, but not yet purchased. See below for the types of cash instruments included in each level of the fair value hierarchy and the valuation techniques and significant inputs used to determine their fair values. See Note 5 for an overview of the firm’s fair value measurement policies.

Level 1 Cash Instruments

Level 1 cash instruments include U.S. government obligations and most non-U.S. government obligations, actively traded listed equities, certain government agency obligations and money market instruments. These instruments are valued using quoted prices for identical unrestricted instruments in active markets.

The firm defines active markets for equity instruments based on the average daily trading volume both in absolute terms and relative to the market capitalization for the instrument. The firm defines active markets for debt instruments based on both the average daily trading volume and the number of days with trading activity.

Level 2 Cash Instruments

Level 2 cash instruments include commercial paper, certificates of deposit, time deposits, most government agency obligations, certain non-U.S. government obligations, most corporate debt securities, commodities, certain mortgage-backed loans and securities, certain bank loans and bridge loans, restricted or less liquid listed equities, most state and municipal obligations and certain lending commitments.

Valuations of level 2 cash instruments can be verified to quoted prices, recent trading activity for identical or similar instruments, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.

Valuation adjustments are typically made to level 2 cash instruments (i) if the cash instrument is subject to transfer restrictions and/or (ii) for other premiums and liquidity discounts that a market participant would require to arrive at fair value. Valuation adjustments are generally based on market evidence.

Level 3 Cash Instruments

Level 3 cash instruments have one or more significant valuation inputs that are not observable. Absent evidence to the contrary, level 3 cash instruments are initially valued at transaction price, which is considered to be the best initial estimate of fair value. Subsequently, the firm uses other methodologies to determine fair value, which vary based on the type of instrument. Valuation inputs and assumptions are changed when corroborated by substantive observable evidence, including values realized on sales of financial assets.

Valuation Techniques and Significant Inputs of Level 3 Cash Instruments

Valuation techniques of level 3 cash instruments vary by instrument, but are generally based on discounted cash flow techniques. The valuation techniques and the nature of significant inputs used to determine the fair values of each type of level 3 cash instrument are described below:

Loans and Securities Backed by Commercial Real Estate. Loans and securities backed by commercial real estate are directly or indirectly collateralized by a single commercial real estate property or a portfolio of properties, and may include tranches of varying levels of subordination. Significant inputs are generally determined based on relative value analyses and include:

 

 

Transaction prices in both the underlying collateral and instruments with the same or similar underlying collateral and the basis, or price difference, to such prices;

 

 

Market yields implied by transactions of similar or related assets and/or current levels and changes in market indices such as the CMBX (an index that tracks the performance of commercial mortgage bonds);

 

 

16   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

A measure of expected future cash flows in a default scenario (recovery rates) implied by the value of the underlying collateral, which is mainly driven by current performance of the underlying collateral, capitalization rates and multiples. Recovery rates are expressed as a percentage of notional or face value of the instrument and reflect the benefit of credit enhancements on certain instruments; and

 

 

Timing of expected future cash flows (duration) which, in certain cases, may incorporate the impact of other unobservable inputs (e.g., prepayment speeds).

Loans and Securities Backed by Residential Real Estate. Loans and securities backed by residential real estate are directly or indirectly collateralized by portfolios of residential real estate and may include tranches of varying levels of subordination. Significant inputs are generally determined based on relative value analyses, which incorporate comparisons to instruments with similar collateral and risk profiles. Significant inputs include:

 

 

Transaction prices in both the underlying collateral and instruments with the same or similar underlying collateral;

 

 

Market yields implied by transactions of similar or related assets;

 

 

Cumulative loss expectations, driven by default rates, home price projections, residential property liquidation timelines, related costs and subsequent recoveries; and

 

 

Duration, driven by underlying loan prepayment speeds and residential property liquidation timelines.

Bank Loans and Bridge Loans. Significant inputs are generally determined based on relative value analyses, which incorporate comparisons both to prices of credit default swaps that reference the same or similar underlying instrument or entity and to other debt instruments for the same issuer for which observable prices or broker quotations are available. Significant inputs include:

 

 

Market yields implied by transactions of similar or related assets and/or current levels and trends of market indices such as CDX and LCDX (indices that track the performance of corporate credit and loans, respectively);

 

 

Current performance and recovery assumptions and, where the firm uses credit default swaps to value the related cash instrument, the cost of borrowing the underlying reference obligation; and

 

 

Duration.

Equities and Convertible Debentures (Including Private Equity Investments and Investments in Real Estate Entities). Recent third-party completed or pending transactions (e.g., merger proposals, tender offers, debt restructurings) are considered to be the best evidence for any change in fair value. When these are not available, the following valuation methodologies are used, as appropriate:

 

 

Industry multiples (primarily EBITDA multiples) and public comparables;

 

 

Transactions in similar instruments;

 

 

Discounted cash flow techniques; and

 

 

Third-party appraisals.

The firm also considers changes in the outlook for the relevant industry and financial performance of the issuer as compared to projected performance. Significant inputs include:

 

 

Market and transaction multiples;

 

 

Discount rates, growth rates and capitalization rates; and

 

 

For equity instruments with debt-like features, market yields implied by transactions of similar or related assets, current performance and recovery assumptions, and duration.

Other Cash Instruments. Other cash instruments consists of commercial paper, certificates of deposit, time deposits and other money market instruments; non-U.S. government and agency obligations; corporate debt securities; state and municipal obligations; and other debt obligations. Significant inputs are generally determined based on relative value analyses, which incorporate comparisons both to prices of credit default swaps that reference the same or similar underlying instrument or entity and to other debt instruments for the same issuer for which observable prices or broker quotations are available. Significant inputs include:

 

 

Market yields implied by transactions of similar or related assets and/or current levels and trends of market indices such as CDX and LCDX;

 

 

Current performance and recovery assumptions and, where the firm uses credit default swaps to value the related cash instrument, the cost of borrowing the underlying reference obligation; and

 

 

Duration.

 

 

    Goldman Sachs September 2016 Form 10-Q   17


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Cash Instruments by Level

The tables below present cash instrument assets and liabilities at fair value by level within the fair value hierarchy. In the tables below:

 

 

Cash instrument assets and liabilities are included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively.

 

 

Cash instrument assets are shown as positive amounts and cash instrument liabilities are shown as negative amounts.

 

    As of September 2016  
$ in millions     Level 1        Level 2        Level 3        Total   

Assets

       

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $       616        $  1,847        $       —        $    2,463   
   

U.S. government and federal agency obligations

    21,999        23,307               45,306   
   

Non-U.S. government and agency obligations

    29,947        8,029        60        38,036   
   

Loans and securities backed by:

       

Commercial real estate

           2,532        1,991        4,523   
   

Residential real estate

           8,416        995        9,411   
   

Bank loans and bridge loans

           7,154        2,705        9,859   
   

Corporate debt securities

    766        18,005        2,357        21,128   
   

State and municipal obligations

           1,613        92        1,705   
   

Other debt obligations

           599        564        1,163   
   

Equities and convertible debentures

    74,242        7,661        9,377        91,280   
   

Commodities

           5,943               5,943   

Subtotal

    $127,570        $85,106        $18,141        $230,817   
   

Investments in funds at NAV

                            6,859   

Total cash instrument assets

                            $237,676   

 

Liabilities

       

U.S. government and federal agency obligations

    $ (14,388     $    (363     $       —        $ (14,751
   

Non-U.S. government and agency obligations

    (18,462     (1,127            (19,589
   

Loans and securities backed by commercial real estate

           (5     (1     (6
   

Bank loans and bridge loans

           (401     (67     (468
   

Corporate debt securities

    (19     (6,280     (14     (6,313
   

Other debt obligations

           (1     (1     (2
   

Equities and convertible debentures

    (29,187     (390     (9     (29,586

Total cash instrument liabilities

    $ (62,056     $ (8,567     $      (92     $ (70,715
    As of December 2015  
$ in millions     Level 1        Level 2        Level 3        Total   

Assets

       

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $       625        $  1,958        $        —        $    2,583   
   

U.S. government and federal agency obligations

    24,844        21,538               46,382   
   

Non-U.S. government and agency obligations

    26,500        5,260        12        31,772   
   

Loans and securities backed by:

       

Commercial real estate

           3,051        1,924        4,975   
   

Residential real estate

           11,418        1,765        13,183   
   

Bank loans and bridge loans

           9,014        3,150        12,164   
   

Corporate debt securities

    218        14,330        2,092        16,640   
   

State and municipal obligations

           891        101        992   
   

Other debt obligations

           1,057        538        1,595   
   

Equities and convertible debentures

    81,252        8,271        8,549        98,072   
   

Commodities

           3,935               3,935   

Subtotal

    $133,439        $80,723        $18,131        $232,293   
   

Investments in funds at NAV

                            7,757   

Total cash instrument assets

                            $240,050   

 

Liabilities

       

U.S. government and federal agency obligations

    $ (15,455     $      (61     $        —        $ (15,516
   

Non-U.S. government and agency obligations

    (13,522     (1,451            (14,973
   

Loans and securities backed by:

       

Commercial real estate

           (4            (4
   

Residential real estate

           (2            (2
   

Bank loans and bridge loans

           (337     (124     (461
   

Corporate debt securities

    (2     (6,119     (2     (6,123
   

State and municipal obligations

           (2            (2
   

Other debt obligations

           (1     (1     (2
   

Equities and convertible debentures

    (30,790     (538     (66     (31,394

Total cash instrument liabilities

    $ (59,769     $ (8,515     $    (193     $ (68,477

In the tables above:

 

 

Total cash instrument assets include collateralized debt obligations (CDOs) and collateralized loan obligations (CLOs) backed by real estate and corporate obligations of $374 million in level 2 and $754 million in level 3 as of September 2016, and $405 million in level 2 and $774 million in level 3 as of December 2015, respectively.

 

 

Level 3 equities and convertible debenture assets include $8.55 billion of private equity investments, $377 million of investments in real estate entities and $449 million of convertible debentures as of September 2016, and $7.69 billion of private equity investments, $308 million of investments in real estate entities and $552 million of convertible debentures as of December 2015.

 

 

18   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Significant Unobservable Inputs

The table below presents the amount of level 3 assets, and ranges and weighted averages of significant unobservable inputs used to value the firm’s level 3 cash instruments.

 

   

Level 3 Assets and Range of Significant

Unobservable Inputs (Weighted Average) as of

 
$ in millions     September 2016        December 2015   

 

Loans and securities backed by commercial real estate

    $1,991        $1,924   
   

Yield

    2.8% to 23.0% (12.1%     3.5% to 22.0% (11.8%
   

Recovery rate

    9.3% to 95.0% (55.9%     19.6% to 96.5% (59.4%
   

Duration (years)

    0.8 to 6.3 (2.5     0.3 to 5.3 (2.3
   

Basis (points)

    N/A        (11) to 4 ((2)

 

Loans and securities backed by residential real estate

    $   995        $1,765   
   

Yield

    1.3% to 15.0% (8.3%     3.2% to 17.0% (7.9%
   

Cumulative loss rate

    14.7% to 50.4% (28.8%     4.6% to 44.2% (27.3%
   

Duration (years)

    1.3 to 16.6 (7.3     1.5 to 13.8 (7.0

 

Bank loans and bridge loans

    $2,705        $3,150   
   

Yield

    2.1% to 20.6% (9.1%     1.9% to 36.6% (10.2%
   

Recovery rate

    6.7% to 85.3% (44.4%     14.5% to 85.6% (51.2%
   

Duration (years)

    0.8 to 5.3 (2.5     0.7 to 6.1 (2.2

 

Equities and convertible debentures

    $9,377        $8,549   
   

Multiples

    0.6x to 18.0x (6.4x     0.7x to 21.4x (6.4x
   

Discount rate/yield

    6.5% to 25.0% (14.9%     7.1% to 20.0% (14.8%
   

Growth rate

    N/A        3.0% to 5.2% (4.5%
   

Capitalization rate

    5.0% to 12.0% (7.1%     5.5% to 12.5% (7.6%

 

Other cash instruments

    $3,073        $2,743   
   

Yield

    1.5% to 18.0% (10.6%     0.9% to 25.6% (10.9%
   

Recovery rate

    0.0% to 91.6% (63.1%     0.0% to 70.0% (59.7%
   

Duration (years)

    0.3 to 13.4 (3.9     1.1 to 11.4 (4.5

In the table above:

 

 

Ranges represent the significant unobservable inputs that were used in the valuation of each type of cash instrument.

 

 

Weighted averages are calculated by weighting each input by the relative fair value of the cash instruments.

 

 

The ranges and weighted averages of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one cash instrument. For example, the highest multiple for private equity investments is appropriate for valuing a specific private equity investment but may not be appropriate for valuing any other private equity investment. Accordingly, the ranges of inputs do not represent uncertainty in, or possible ranges of, fair value measurements of the firm’s level 3 cash instruments.

 

Increases in yield, discount rate, capitalization rate, duration or cumulative loss rate used in the valuation of the firm’s level 3 cash instruments would result in a lower fair value measurement, while increases in recovery rate, basis, multiples or growth rate would result in a higher fair value measurement. Due to the distinctive nature of each of the firm’s level 3 cash instruments, the interrelationship of inputs is not necessarily uniform within each product type.

 

 

Equities and convertible debentures include private equity investments and investments in real estate entities. Growth rate includes long-term growth rate and compound annual growth rate.

 

 

Loans and securities backed by commercial and residential real estate, bank loans and bridge loans and other cash instruments are valued using discounted cash flows, and equities and convertible debentures are valued using market comparables and discounted cash flows.

 

 

The fair value of any one instrument may be determined using multiple valuation techniques. For example, market comparables and discounted cash flows may be used together to determine fair value. Therefore, the level 3 balance encompasses both of these techniques.

Transfers Between Levels of the Fair Value Hierarchy

Transfers between levels of the fair value hierarchy are reported at the beginning of the reporting period in which they occur.

During the three and nine months ended September 2016, transfers into level 2 from level 1 of cash instruments were $143 million and $88 million, respectively, reflecting transfers of public equity securities primarily due to decreased market activity in these instruments. Transfers into level 1 from level 2 of cash instruments during the three and nine months ended September 2016, were $200 million and $203 million, respectively, reflecting transfers of public equity securities, principally due to increased market activity in these instruments.

During the three and nine months ended September 2015, transfers into level 2 from level 1 of cash instruments were $95 million and $138 million, respectively, reflecting transfers of public equity securities primarily due to decreased market activity in these instruments. Transfers into level 1 from level 2 of cash instruments during the three and nine months ended September 2015, were $113 million and $264 million, respectively, reflecting transfers of public equity securities, principally due to increased market activity in these instruments.

See “Level 3 Rollforward” below for information about transfers between level 2 and level 3.

 

 

    Goldman Sachs September 2016 Form 10-Q   19


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward

The table below presents changes in fair value for all cash instrument assets and liabilities categorized as level 3 as of the end of the period. In the table below:

 

 

If a cash instrument asset or liability was transferred to level 3 during a reporting period, its entire gain or loss for the period is included in level 3. For level 3 cash instrument assets, increases are shown as positive amounts, while decreases are shown as negative amounts. For level 3 cash instrument liabilities, increases are shown as negative amounts, while decreases are shown as positive amounts.

 

 

Level 3 cash instruments are frequently economically hedged with level 1 and level 2 cash instruments and/or level 1, level 2 or level 3 derivatives. Accordingly, gains or losses that are reported in level 3 can be partially offset by gains or losses attributable to level 1 or level 2 cash instruments and/or level 1, level 2 or level 3 derivatives. As a result, gains or losses included in the level 3 rollforward below do not necessarily represent the overall impact on the firm’s results of operations, liquidity or capital resources.

 

 

Purchases include both originations and secondary market purchases.

 

 

Net unrealized gains/(losses) relate to instruments that were still held at period-end.

 

 

For the three months ended September 2016, the net realized and unrealized gains on level 3 cash instrument assets of $655 million (reflecting $194 million of realized gains and $461 million of unrealized gains) include gains/(losses) of approximately $(65) million, $487 million and $233 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

 

For the nine months ended September 2016, the net realized and unrealized gains on level 3 cash instrument assets of $861 million (reflecting $503 million of realized gains and $358 million of unrealized gains) include gains/(losses) of approximately $(394) million, $557 million and $698 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

 

For the three months ended September 2015, the net realized and unrealized gains on level 3 cash instrument assets of $179 million (reflecting $231 million of realized gains and $52 million of unrealized losses) include gains/(losses) of approximately $(39) million, $(18) million and $236 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

 

For the nine months ended September 2015, the net realized and unrealized gains on level 3 cash instrument assets of $1.67 billion (reflecting $821 million of realized gains and $844 million of unrealized gains) include gains/(losses) of approximately $(10) million, $1.13 billion and $547 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

See “Level 3 Rollforward Commentary” below for an explanation of the net unrealized gains/(losses) on level 3 cash instruments and the activity related to transfers into and out of level 3.

 

 

20   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

    Level 3 Cash Instrument Assets and Liabilities at Fair Value  
$ in millions    

 

 

Balance,

beginning

of period

  

  

  

   

 

 

 

Net

realized

gains/

(losses)

  

  

  

  

   

 

 

 

Net

unrealized

gains/

(losses)

  

  

  

  

    Purchases         Sales        Settlements       

 

 

Transfers

into

level 3

  

  

  

   

 

 

Transfers

out of

level 3

  

  

  

   

 

 

Balance,

end of

period

  

  

  

Three Months Ended September 2016

                  

Non-U.S. government and agency obligations

    $       61        $   —        $    2        $      —         $       (5     $         1        $        1        $       —        $       60   
   

Loans and securities backed by:

                  

Commercial real estate

    2,112        12        59        46         (97     (144     119        (116     1,991   
   

Residential real estate

    1,300        15        (5     76         (123     (85     95        (278     995   
   

Bank loans and bridge loans

    2,911        59        49        112         (37     (432     118        (75     2,705   
   

Corporate debt securities

    2,422        48        58        166         (285     (215     225        (62     2,357   
   

State and municipal obligations

    92        1               4         (12     (2     10        (1     92   
   

Other debt obligations

    528        7        7        19         (7     (39     55        (6     564   
   

Equities and convertible debentures

    8,705        52        291        96         (137     (165     704        (169     9,377   

Total cash instrument assets

    $18,131        $194        $461        $   519         $   (703     $ (1,081     $1,327        $   (707     $18,141   

Total cash instrument liabilities

    $    (123     $  25        $  18        $     51         $     (38     $         1        $    (26     $       —        $      (92

 

Nine Months Ended September 2016

                  

Non-U.S. government and agency obligations

    $       12        $   (4     $  10        $     17         $     (11     $       —        $     36        $       —        $       60   
   

Loans and securities backed by:

                  

Commercial real estate

    1,924        58        14        491         (292     (459     516        (261     1,991   
   

Residential real estate

    1,765        38        45        297         (780     (233     120        (257     995   
   

Bank loans and bridge loans

    3,150        112        (18     452         (148     (1,090     457        (210     2,705   
   

Corporate debt securities

    2,092        132        82        501         (329     (463     492        (150     2,357   
   

State and municipal obligations

    101        2               9         (31     (2     25        (12     92   
   

Other debt obligations

    538        27        (27     217         (110     (120     42        (3     564   
   

Equities and convertible debentures

    8,549        138        252        957         (301     (555     1,008        (671     9,377   

Total cash instrument assets

    $18,131        $503        $358        $2,941         $(2,002     $ (2,922     $2,696        $(1,564     $18,141   

Total cash instrument liabilities

    $    (193     $  27        $  32        $     88         $     (61     $        (6     $      (9     $      30        $      (92

 

Three Months Ended September 2015

                  

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $       11        $   —        $   —        $      —         $      (10     $        (1     $      —        $       —        $        —   
   

Non-U.S. government and agency obligations

    21                                     (9     1               13   
   

Loans and securities backed by:

                  

Commercial real estate

    2,134        22        28        232         (100     (131     87        (167     2,105   
   

Residential real estate

    2,717        24        29        91         (238     (76     69        (976     1,640   
   

Bank loans and bridge loans

    5,377        55        (77     243         (43     (574     152        (1,372     3,761   
   

Corporate debt securities

    2,595        51        (34     95         (153     (19     161        (378     2,318   
   

State and municipal obligations

    143                      7         (9            12        (64     89   
   

Other debt obligations

    740        2        4        16         (63     (102            (56     541   
   

Equities and convertible debentures

    12,457        77        (2     177         (93     (514     212        (2,476     9,838   

Total cash instrument assets

    $26,195        $231        $ (52     $   861         $    (709     $ (1,426     $   694        $ (5,489     $20,305   

Total cash instrument liabilities

    $    (178     $  13        $ (31     $   102         $      (35     $         3        $    (98     $         5        $    (219

 

Nine Months Ended September 2015

                  

Non-U.S. government and agency obligations

    $     136        $    9        $   —        $       1         $      (35     $      (24     $      —        $      (74     $       13   
   

Loans and securities backed by:

                  

Commercial real estate

    3,275        120        91        429         (605     (1,332     340        (213     2,105   
   

Residential real estate

    2,545        115        19        387         (639     (255     158        (690     1,640   
   

Bank loans and bridge loans

    6,973        228        (177     760         (833     (1,481     389        (2,098     3,761   
   

Corporate debt securities

    3,633        128        (58     455         (448     (399     345        (1,338     2,318   
   

State and municipal obligations

    110        3        2        11         (21     (2     12        (26     89   
   

Other debt obligations

    870        21        5        91         (192     (82     2        (174     541   
   

Equities and convertible debentures

    11,108        197        962        676         (489     (1,313     885        (2,188     9,838   

Total cash instrument assets

    $28,650        $821        $844        $2,810         $ (3,262     $ (4,888     $2,131        $  (6,801     $20,305   

Total cash instrument liabilities

    $    (244     $  12        $ (26     $   170              (45     $        (6     $  (121     $       41        $    (219

 

    Goldman Sachs September 2016 Form 10-Q   21


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward Commentary

Three Months Ended September 2016. The net unrealized gain on level 3 cash instruments of $479 million (reflecting $461 million on cash instrument assets and $18 million on cash instrument liabilities) for the three months ended September 2016 primarily reflected gains on private equity investments, principally driven by strong corporate performance and company-specific events.

Transfers into level 3 during the three months ended September 2016 primarily reflected transfers of private equity investments and corporate debt securities from level 2, principally due to reduced price transparency as a result of a lack of market evidence, including fewer market transactions in these instruments.

Transfers out of level 3 during the three months ended September 2016 primarily reflected transfers of loans and securities backed by residential real estate and private equity investments to level 2, principally due to increased price transparency as a result of market evidence, including market transactions in these instruments.

Nine Months Ended September 2016. The net unrealized gain on level 3 cash instruments of $390 million (reflecting $358 million on cash instrument assets and $32 million on cash instrument liabilities) for the nine months ended September 2016 primarily reflected gains on private equity investments, principally driven by strong corporate performance and company-specific events.

Transfers into level 3 during the nine months ended September 2016 primarily reflected transfers of private equity investments, loans and securities backed by commercial real estate, corporate debt securities and bank loans and bridge loans from level 2, principally due to reduced price transparency as a result of a lack of market evidence, including fewer transactions in these instruments.

Transfers out of level 3 during the nine months ended September 2016 primarily reflected transfers of private equity investments, loans and securities backed by commercial and residential real estate and bank loans and bridge loans to level 2, principally due to increased price transparency as a result of market evidence, including market transactions in these instruments.

Three Months Ended September 2015. The net unrealized loss on level 3 cash instruments of $83 million (reflecting $52 million on cash instrument assets and $31 million on cash instrument liabilities) for the three months ended September 2015 primarily reflected losses on bank loans and bridge loans, principally reflecting the impact of wider credit spreads.

Transfers into level 3 during the three months ended September 2015 primarily reflected transfers of certain private equity investments, corporate debt securities and bank loans and bridge loans from level 2 principally due to reduced price transparency as a result of a lack of market evidence, including fewer market transactions in these instruments.

Transfers out of level 3 during the three months ended September 2015 primarily reflected transfers of certain private equity investments and loans and securities backed by residential real estate to level 2 principally due to increased price transparency as a result of market evidence, including market transactions in these instruments, and transfers of certain bank loans and bridge loans to level 2 principally due to certain unobservable yield and duration inputs not being significant to the valuation of these instruments.

Nine Months Ended September 2015. The net unrealized gain on level 3 cash instruments of $818 million (reflecting $844 million of gains on cash instrument assets and $26 million of losses on cash instrument liabilities) for the nine months ended September 2015 primarily reflected gains on private equity investments principally driven by strong corporate performance and company-specific events.

Transfers into level 3 during the nine months ended September 2015 primarily reflected transfers of certain private equity investments, bank loans and bridge loans, corporate debt securities and loans and securities backed by commercial real estate from level 2 principally due to reduced price transparency as a result of a lack of market evidence, including fewer transactions in these instruments.

Transfers out of level 3 during the nine months ended September 2015 primarily reflected transfers of certain private equity investments, corporate debt securities and loans and securities backed by residential real estate to level 2 principally due to increased price transparency as a result of market evidence, including market transactions in these instruments, and transfers of certain bank loans and bridge loans to level 2 principally due to certain unobservable yield and duration inputs not being significant to the valuation of these instruments.

 

 

22   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Investments in Funds at Net Asset Value Per Share

Cash instruments at fair value include investments in funds that are measured at NAV of the investment fund. The firm uses NAV to measure the fair value of its fund investments when (i) the fund investment does not have a readily determinable fair value and (ii) the NAV of the investment fund is calculated in a manner consistent with the measurement principles of investment company accounting, including measurement of the investments at fair value.

The firm’s investments in funds at NAV primarily consist of investments in firm-sponsored private equity, credit, real estate and hedge funds where the firm co-invests with third-party investors.

Private equity funds primarily invest in a broad range of industries worldwide, including leveraged buyouts, recapitalizations, growth investments and distressed investments. Credit funds generally invest in loans and other fixed income instruments and are focused on providing private high-yield capital for leveraged and management buyout transactions, recapitalizations, financings, refinancings, acquisitions and restructurings for private equity firms, private family companies and corporate issuers. Real estate funds invest globally, primarily in real estate companies, loan portfolios, debt recapitalizations and property. The private equity, credit and real estate funds are primarily closed-end funds in which the firm’s investments are generally not eligible for redemption. Distributions will be received from these funds as the underlying assets are liquidated or distributed.

The firm also invests in hedge funds, primarily multi-disciplinary hedge funds that employ a fundamental bottom-up investment approach across various asset classes and strategies. The firm’s investments in hedge funds primarily include interests where the underlying assets are illiquid in nature, and proceeds from redemptions will not be received until the underlying assets are liquidated or distributed.

Many of the funds described above are “covered funds” as defined by the Volcker Rule of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Board of Governors of the Federal Reserve System (Federal Reserve Board) extended the conformance period through July 2017 for investments in, and relationships with, covered funds that were in place prior to December 2013. To the extent that the underlying investments of particular funds are not sold within the conformance period, the firm may be required to sell its interests in such funds. If that occurs, the firm may receive a value for its interests that is less than the then carrying value as there could be a limited secondary market for these investments and the firm may be unable to sell them in orderly transactions. In order to be compliant with the Volcker Rule, the firm will be required to reduce most of its interests in the funds in the table below by the end of the conformance period.

The table below presents the fair value of the firm’s investments in funds at NAV and related unfunded commitments.

 

$ in millions    
 
Fair Value of
Investments
  
  
    
 
Unfunded
Commitments
  
  

As of September 2016

    

Private equity funds

    $4,803         $1,398   
   

Credit funds

    478         214   
   

Hedge funds

    471           
   

Real estate funds

    1,107         200   

Total

    $6,859         $1,812   

 

As of December 2015

    

Private equity funds

    $5,414         $2,057   
   

Credit funds

    611         344   
   

Hedge funds

    560           
   

Real estate funds

    1,172         296   

Total

    $7,757         $2,697   
 

 

    Goldman Sachs September 2016 Form 10-Q   23


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 7.

Derivatives and Hedging Activities

Derivative Activities

Derivatives are instruments that derive their value from underlying asset prices, indices, reference rates and other inputs, or a combination of these factors. Derivatives may be traded on an exchange (exchange-traded) or they may be privately negotiated contracts, which are usually referred to as OTC derivatives. Certain of the firm’s OTC derivatives are cleared and settled through central clearing counterparties (OTC-cleared), while others are bilateral contracts between two counterparties (bilateral OTC).

Market-Making. As a market maker, the firm enters into derivative transactions to provide liquidity to clients and to facilitate the transfer and hedging of their risks. In this capacity, the firm typically acts as principal and is required to commit capital to provide execution. As a market maker, it is essential to maintain an inventory of financial instruments sufficient to meet expected client and market demands.

Risk Management. The firm also enters into derivatives to actively manage risk exposures that arise from its market-making and investing and lending activities in derivative and cash instruments. The firm’s holdings and exposures are hedged, in many cases, on either a portfolio or risk-specific basis, as opposed to an instrument-by-instrument basis. The offsetting impact of this economic hedging is reflected in the same business segment as the related revenues. In addition, the firm may enter into derivatives designated as hedges under U.S. GAAP. These derivatives are used to manage interest rate exposure in certain fixed-rate unsecured long-term and short-term borrowings, and deposits, and to manage foreign currency exposure on the net investment in certain non-U.S. operations.

The firm enters into various types of derivatives, including:

 

 

Futures and Forwards. Contracts that commit counterparties to purchase or sell financial instruments, commodities or currencies in the future.

 

 

Swaps. Contracts that require counterparties to exchange cash flows such as currency or interest payment streams. The amounts exchanged are based on the specific terms of the contract with reference to specified rates, financial instruments, commodities, currencies or indices.

 

 

Options. Contracts in which the option purchaser has the right, but not the obligation, to purchase from or sell to the option writer financial instruments, commodities or currencies within a defined time period for a specified price.

Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) when a legal right of setoff exists under an enforceable netting agreement (counterparty netting). Derivatives are accounted for at fair value, net of cash collateral received or posted under enforceable credit support agreements (cash collateral netting). Derivative assets and liabilities are included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively. Realized and unrealized gains and losses on derivatives not designated as hedges under ASC 815 are included in “Market making” and “Other principal transactions” in Note 4.

 

 

24   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents the gross fair value and the notional amount of derivative contracts by major product type, the amounts of counterparty and cash collateral netting in the condensed consolidated statements of financial condition, as well as cash and securities collateral posted and received under enforceable credit support agreements that do not meet the criteria for netting under U.S. GAAP. In the table below:

 

 

Gross fair values exclude the effects of both counterparty netting and collateral, and therefore are not representative of the firm’s exposure.

 

 

Where the firm has received or posted collateral under credit support agreements, but has not yet determined such agreements are enforceable, the related collateral has not been netted.

 

Notional amounts, which represent the sum of gross long and short derivative contracts, provide an indication of the volume of the firm’s derivative activity and do not represent anticipated losses.

 

 

Total gross fair value of derivatives includes derivative assets and derivative liabilities of $17.91 billion and $16.78 billion, respectively, as of September 2016, and derivative assets and derivative liabilities of $17.09 billion and $18.16 billion, respectively, as of December 2015, which are not subject to an enforceable netting agreement or are subject to a netting agreement that the firm has not yet determined to be enforceable.

 

 

    As of September 2016         As of December 2015  
$ in millions    
 
Derivative
Assets
  
  
   
 
Derivative
Liabilities
  
  
   
 
Notional
Amount
  
  
       
 
Derivative
Assets
  
  
   
 
Derivative
Liabilities
  
  
   
 
Notional
Amount
  
  

Derivatives not accounted for as hedges

             

Exchange-traded

    $        376        $        425        $  5,007,835          $        310        $        280        $  4,402,843   
   

OTC-cleared

    299,669        281,538        19,319,515          211,272        192,401        20,738,687   
   

Bilateral OTC

    441,056        415,105        11,870,373            345,516        321,458        12,953,830   

Total interest rates

    741,101        697,068        36,197,723            557,098        514,139        38,095,360   

OTC-cleared

    5,187        5,071        412,498          5,203        5,596        339,244   
   

Bilateral OTC

    25,464        22,235        1,225,769            35,679        31,179        1,552,806   

Total credit

    30,651        27,306        1,638,267            40,882        36,775        1,892,050   

Exchange-traded

    13        134        9,709          183        204        13,073   
   

OTC-cleared

    228        297        43,677          165        128        14,617   
   

Bilateral OTC

    82,437        79,377        5,674,447            96,660        99,235        5,461,940   

Total currencies

    82,678        79,808        5,727,833            97,008        99,567        5,489,630   

Exchange-traded

    4,674        4,190        283,543          2,997        3,623        203,465   
   

OTC-cleared

    176        214        2,846          232        233        2,839   
   

Bilateral OTC

    9,021        10,579        198,855            17,445        17,215        230,750   

Total commodities

    13,871        14,983        485,244            20,674        21,071        437,054   

Exchange-traded

    8,088        8,391        624,544          9,372        7,908        528,419   
   

Bilateral OTC

    39,169        39,984        970,472            37,788        38,290        927,078   

Total equities

    47,257        48,375        1,595,016            47,160        46,198        1,455,497   

Subtotal

    915,558        867,540        45,644,083            762,822        717,750        47,369,591   

Derivatives accounted for as hedges

             

OTC-cleared

    6,462        30        57,947          4,567        85        51,446   
   

Bilateral OTC

    5,494        1        42,065            6,660        20        62,022   

Total interest rates

    11,956        31        100,012            11,227        105        113,468   

OTC-cleared

    2        46        1,538          24        6        1,333   
   

Bilateral OTC

    27        60        8,947            116        27        8,615   

Total currencies

    29        106        10,485            140        33        9,948   

Subtotal

    11,985        137        110,497            11,367        138        123,416   

Total gross fair value/notional amount of derivatives

    $ 927,543        $ 867,677        $45,754,580            $ 774,189        $ 717,888        $47,493,007   

Amounts offset in the condensed consolidated statements of financial condition

             

Exchange-traded

    $  (11,276     $  (11,276         $    (9,398     $    (9,398  
   

OTC-cleared

    (284,021     (284,021         (194,928     (194,928  
   

Bilateral OTC

    (478,894     (478,894                 (426,841     (426,841        

Total counterparty netting

    (774,191     (774,191                 (631,167     (631,167        

OTC-cleared

    (27,059     (2,542         (26,151     (3,305  
   

Bilateral OTC

    (71,549     (46,505                 (62,981     (36,645        

Total cash collateral netting

    (98,608     (49,047                 (89,132     (39,950        

Total counterparty and cash collateral netting

    $(872,799     $(823,238                 $(720,299     $(671,117        

Included in the condensed consolidated statements of financial condition

             

Exchange-traded

    $     1,875        $     1,864            $     3,464        $     2,617     
   

OTC-cleared

    644        633            384        216     
   

Bilateral OTC

    52,225        41,942                    50,042        43,938           

Total included in the condensed consolidated statements of financial condition

    $   54,744        $   44,439                    $   53,890        $   46,771           

Amounts not offset in the condensed consolidated statements of financial  condition

             

Cash collateral received/posted

    $       (522     $    (2,016         $       (498     $    (1,935  
   

Securities collateral received/posted

    (17,910     (14,193                 (14,008     (10,044        

Total

    $   36,312        $   28,230                    $   39,384        $   34,792           

 

    Goldman Sachs September 2016 Form 10-Q   25


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Valuation Techniques for Derivatives

The firm’s level 2 and level 3 derivatives are valued using derivative pricing models (e.g., discounted cash flow models, correlation models, and models that incorporate option pricing methodologies, such as Monte Carlo simulations). Price transparency of derivatives can generally be characterized by product type, as described below.

 

 

Interest Rate. In general, the key inputs used to value interest rate derivatives are transparent, even for most long-dated contracts. Interest rate swaps and options denominated in the currencies of leading industrialized nations are characterized by high trading volumes and tight bid/offer spreads. Interest rate derivatives that reference indices, such as an inflation index, or the shape of the yield curve (e.g., 10-year swap rate vs. 2-year swap rate) are more complex, but the key inputs are generally observable.

 

 

Credit. Price transparency for credit default swaps, including both single names and baskets of credits, varies by market and underlying reference entity or obligation. Credit default swaps that reference indices, large corporates and major sovereigns generally exhibit the most price transparency. For credit default swaps with other underliers, price transparency varies based on credit rating, the cost of borrowing the underlying reference obligations, and the availability of the underlying reference obligations for delivery upon the default of the issuer. Credit default swaps that reference loans, asset-backed securities and emerging market debt instruments tend to have less price transparency than those that reference corporate bonds. In addition, more complex credit derivatives, such as those sensitive to the correlation between two or more underlying reference obligations, generally have less price transparency.

 

 

Currency. Prices for currency derivatives based on the exchange rates of leading industrialized nations, including those with longer tenors, are generally transparent. The primary difference between the price transparency of developed and emerging market currency derivatives is that emerging markets tend to be observable for contracts with shorter tenors.

 

Commodity. Commodity derivatives include transactions referenced to energy (e.g., oil and natural gas), metals (e.g., precious and base) and soft commodities (e.g., agricultural). Price transparency varies based on the underlying commodity, delivery location, tenor and product quality (e.g., diesel fuel compared to unleaded gasoline). In general, price transparency for commodity derivatives is greater for contracts with shorter tenors and contracts that are more closely aligned with major and/or benchmark commodity indices.

 

 

Equity. Price transparency for equity derivatives varies by market and underlier. Options on indices and the common stock of corporates included in major equity indices exhibit the most price transparency. Equity derivatives generally have observable market prices, except for contracts with long tenors or reference prices that differ significantly from current market prices. More complex equity derivatives, such as those sensitive to the correlation between two or more individual stocks, generally have less price transparency.

Liquidity is essential to observability of all product types. If transaction volumes decline, previously transparent prices and other inputs may become unobservable. Conversely, even highly structured products may at times have trading volumes large enough to provide observability of prices and other inputs. See Note 5 for an overview of the firm’s fair value measurement policies.

Level 1 Derivatives

Level 1 derivatives include short-term contracts for future delivery of securities when the underlying security is a level 1 instrument, and exchange-traded derivatives if they are actively traded and are valued at their quoted market price.

Level 2 Derivatives

Level 2 derivatives include OTC derivatives for which all significant valuation inputs are corroborated by market evidence and exchange-traded derivatives that are not actively traded and/or that are valued using models that calibrate to market-clearing levels of OTC derivatives. In evaluating the significance of a valuation input, the firm considers, among other factors, a portfolio’s net risk exposure to that input.

 

 

26   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The selection of a particular model to value a derivative depends on the contractual terms of and specific risks inherent in the instrument, as well as the availability of pricing information in the market. For derivatives that trade in liquid markets, model selection does not involve significant management judgment because outputs of models can be calibrated to market-clearing levels.

Valuation models require a variety of inputs, such as contractual terms, market prices, yield curves, discount rates (including those derived from interest rates on collateral received and posted as specified in credit support agreements for collateralized derivatives), credit curves, measures of volatility, prepayment rates, loss severity rates and correlations of such inputs. Significant inputs to the valuations of level 2 derivatives can be verified to market transactions, broker or dealer quotations or other alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.

Level 3 Derivatives

Level 3 derivatives are valued using models which utilize observable level 1 and/or level 2 inputs, as well as unobservable level 3 inputs. The significant unobservable inputs used to value the firm’s level 3 derivatives are described below.

 

 

For the majority of the firm’s interest rate and currency derivatives classified within level 3, significant unobservable inputs include correlations of certain currencies and interest rates (e.g., the correlation between Euro inflation and Euro interest rates) and specific interest rate volatilities.

 

 

For level 3 credit derivatives, significant unobservable inputs include illiquid credit spreads and upfront credit points, which are unique to specific reference obligations and reference entities, recovery rates and certain correlations required to value credit derivatives (e.g., the likelihood of default of the underlying reference obligation relative to one another).

 

For level 3 commodity derivatives, significant unobservable inputs include volatilities for options with strike prices that differ significantly from current market prices and prices or spreads for certain products for which the product quality or physical location of the commodity is not aligned with benchmark indices.

 

 

For level 3 equity derivatives, significant unobservable inputs generally include equity volatility inputs for options that are long-dated and/or have strike prices that differ significantly from current market prices. In addition, the valuation of certain structured trades requires the use of level 3 correlation inputs, such as the correlation of the price performance of two or more individual stocks or the correlation of the price performance for a basket of stocks to another asset class such as commodities.

Subsequent to the initial valuation of a level 3 derivative, the firm updates the level 1 and level 2 inputs to reflect observable market changes and any resulting gains and losses are recorded in level 3. Level 3 inputs are changed when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations or other empirical market data. In circumstances where the firm cannot verify the model value by reference to market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value. See below for further information about significant unobservable inputs used in the valuation of level 3 derivatives.

Valuation Adjustments

Valuation adjustments are integral to determining the fair value of derivative portfolios and are used to adjust the mid-market valuations produced by derivative pricing models to the appropriate exit price valuation. These adjustments incorporate bid/offer spreads, the cost of liquidity, credit valuation adjustments and funding valuation adjustments, which account for the credit and funding risk inherent in the uncollateralized portion of derivative portfolios. The firm also makes funding valuation adjustments to collateralized derivatives where the terms of the agreement do not permit the firm to deliver or repledge collateral received. Market-based inputs are generally used when calibrating valuation adjustments to market-clearing levels.

In addition, for derivatives that include significant unobservable inputs, the firm makes model or exit price adjustments to account for the valuation uncertainty present in the transaction.

 

 

    Goldman Sachs September 2016 Form 10-Q   27


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Derivatives by Level

The tables below present the fair value of derivatives on a gross basis by level and major product type as well as the impact of netting, included in the condensed consolidated statements of financial condition.

 

    As of September 2016  
$ in millions     Level 1        Level 2        Level 3        Total   

Assets

       

Interest rates

    $     9        $ 752,087        $    961        $ 753,057   
   

Credit

           24,863        5,788        30,651   
   

Currencies

           82,474        233        82,707   
   

Commodities

           13,469        402        13,871   
   

Equities

    11        46,612        634        47,257   

Gross fair value

    20        919,505        8,018        927,543   
   

Counterparty netting within levels

    (1     (770,662     (1,925     (772,588

Subtotal

    $   19        $ 148,843        $ 6,093        $ 154,955   
   

Cross-level counterparty netting

          (1,603
   

Cash collateral netting

  

                    (98,608

Net fair value

  

    $   54,744   

 

Liabilities

       

Interest rates

    $  (22     $(696,170     $   (907     $(697,099
   

Credit

           (24,429     (2,877     (27,306
   

Currencies

           (79,713     (201     (79,914
   

Commodities

           (14,579     (404     (14,983
   

Equities

    (554     (46,484     (1,337     (48,375

Gross fair value

    (576     (861,375     (5,726     (867,677
   

Counterparty netting within levels

    1        770,662        1,925        772,588   

Subtotal

    $(575     $  (90,713     $(3,801     $  (95,089
   

Cross-level counterparty netting

          1,603   
   

Cash collateral netting

  

                    49,047   

Net fair value

  

    $  (44,439

 

    As of December 2015  
$ in millions     Level 1        Level 2        Level 3        Total   

Assets

       

Interest rates

    $     4        $ 567,761        $    560        $ 568,325   
   

Credit

           34,832        6,050        40,882   
   

Currencies

           96,959        189        97,148   
   

Commodities

           20,087        587        20,674   
   

Equities

    46        46,491        623        47,160   

Gross fair value

    50        766,130        8,009        774,189   
   

Counterparty netting within levels

           (627,548     (2,139     (629,687

Subtotal

    $   50        $ 138,582        $ 5,870        $ 144,502   
   

Cross-level counterparty netting

  

    (1,480
   

Cash collateral netting

  

                    (89,132

Net fair value

  

    $   53,890   

 

Liabilities

       

Interest rates

    $  (11     $(513,275     $   (958     $(514,244
   

Credit

           (33,518     (3,257     (36,775
   

Currencies

           (99,377     (223     (99,600
   

Commodities

           (20,222     (849     (21,071
   

Equities

    (18     (43,953     (2,227     (46,198

Gross fair value

    (29     (710,345     (7,514     (717,888
   

Counterparty netting within levels

           627,548        2,139        629,687   

Subtotal

    $  (29     $  (82,797     $(5,375     $  (88,201
   

Cross-level counterparty netting

  

    1,480   
   

Cash collateral netting

  

                    39,950   

Net fair value

  

    $  (46,771

In the tables above:

 

 

The gross fair values exclude the effects of both counterparty netting and collateral netting, and therefore are not representative of the firm’s exposure.

 

 

Counterparty netting is reflected in each level to the extent that receivable and payable balances are netted within the same level and is included in Counterparty netting within levels. Where the counterparty netting is across levels, the netting is reflected in Cross-level counterparty netting.

 

 

Derivative assets are shown as positive amounts and derivative liabilities are shown as negative amounts.

 

 

28   Goldman Sachs September 2016 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Significant Unobservable Inputs

The table below presents the amount of level 3 assets (liabilities), and ranges, averages and medians of significant unobservable inputs used to value the firm’s level 3 derivatives.

 

   

Level 3 Assets (Liabilities) and Range of Significant

Unobservable Inputs (Average / Median) as of

 
$ in millions     September 2016        December 2015   

 

Interest rates — net

    $54        $(398
   

Correlation

    (10)% to 86% (56% / 60%     (25)% to 92% (53% / 55%
   

Volatility (bps per annum)

    31 to 151 (84 / 57     31 to 152 (84 / 57

 

Credit — net

    $2,911        $2,793   
   

Correlation

    29% to 92% (60% / 59%     46% to 99% (68% / 66%
   

Credit spreads (bps)

    1 to 960 (113 / 68     1 to 1,019 (129 / 86
   

Upfront credit points

    0 to 100 (42 / 37     0 to 100 (41 / 40
   

Recovery rates

    1% to 97% (61% / 70%     2% to 97% (58% / 70%

 

Currencies — net

    $32        $(34
   

Correlation

    25% to 70% (51% / 55%     25% to 70% (50% / 51%

 

Commodities — net

    $(2     $(262
   

Volatility

    10% to 67% (34% / 34%     11% to 77% (35% / 34%
   

Natural gas spread

    $(2.20) to $4.01 ($(0.06) / $(0.02)     $(1.32) to $4.15 ($(0.05) / $(0.01)
   

Oil spread

    $(11.15) to $64.66 ($10.95 / $6.92     $(10.64) to $65.29 ($3.34 / $(3.31)

 

Equities — net

    $(703     $(1,604
   

Correlation

    (49)% to 87% (44% / 45%     (65)% to 94% (42% / 48%
   

Volatility

    5% to 107% (25% / 24%     5% to 76% (24% / 23%

In the table above:

 

 

Derivative assets are shown as positive amounts and derivative liabilities are shown as negative amounts.

 

 

Ranges represent the significant unobservable inputs that were used in the valuation of each type of derivative.

 

 

Averages represent the arithmetic average of the inputs and are not weighted by the relative fair value or notional of the respective financial instruments. An average greater than the median indicates that the majority of inputs are below the average. For example, the difference between the average and the median for credit spreads and oil spread inputs indicates that the majority of the inputs fall in the lower end of the range.

 

The ranges, averages and medians of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one derivative. For example, the highest correlation for interest rate derivatives is appropriate for valuing a specific interest rate derivative but may not be appropriate for valuing any other interest rate derivative. Accordingly, the ranges of inputs do not represent uncertainty in, or possible ranges of, fair value measurements of the firm’s level 3 derivatives.

 

 

Interest rates, currencies and equities derivatives are valued using option pricing models, credit derivatives are valued using option pricing, correlation and discounted cash flow models, and commodities derivatives are valued using option pricing and discounted cash flow models.

 

 

The fair value of any one instrument may be determined using multiple valuation techniques. For example, option pricing models and discounted cash flows models are typically used together to determine fair value. Therefore, the level 3 balance encompasses both of these techniques.

 

 

Correlation within currencies and equities includes cross-product correlation. Natural gas spread represents the spread per million British thermal units of natural gas.

 

 

Oil spread represents the spread per barrel of oil and refined products.

 

 

    Goldman Sachs September 2016 Form 10-Q   29


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Range of Significant Unobservable Inputs

The following is information about the ranges of significant unobservable inputs used to value the firm’s level 3 derivative instruments:

 

 

Correlation. Ranges for correlation cover a variety of underliers both within one market (e.g., equity index and equity single stock names) and across markets (e.g., correlation of an interest rate and a foreign exchange rate), as well as across regions. Generally, cross-product correlation inputs are used to value more complex instruments and are lower than correlation inputs on assets within the same derivative product type.

 

 

Volatility. Ranges for volatility cover numerous underliers across a variety of markets, maturities and strike prices. For example, volatility of equity indices is generally lower than volatility of single stocks.

 

 

Credit spreads, upfront credit points and recovery rates. The ranges for credit spreads, upfront credit points and recovery rates cover a variety of underliers (index and single names), regions, sectors, maturities and credit qualities (high-yield and investment-grade). The broad range of this population gives rise to the width of the ranges of significant unobservable inputs.

 

 

Commodity prices and spreads. The ranges for commodity prices and spreads cover variability in products, maturities and delivery locations.

Sensitivity of Fair Value Measurement to Changes in Significant Unobservable Inputs

The following is a description of the directional sensitivity of the firm’s level 3 fair value measurements to changes in significant unobservable inputs, in isolation:

 

 

Correlation. In general, for contracts where the holder benefits from the convergence of the underlying asset or index prices (e.g., interest rates, credit spreads, foreign exchange rates, inflation rates and equity prices), an increase in correlation results in a higher fair value measurement.

 

 

Volatility. In general, for purchased options, an increase in volatility results in a higher fair value measurement.

 

Credit spreads, upfront credit points and recovery rates. In general, the fair value of purchased credit protection increases as credit spreads or upfront credit points increase or recovery rates decrease. Credit spreads, upfront credit points and recovery rates are strongly related to distinctive risk factors of the underlying reference obligations, which include reference entity-specific factors such as leverage, volatility and industry, market-based risk factors, such as borrowing costs or liquidity of the underlying reference obligation, and macroeconomic conditions.

 

 

Commodity prices and spreads. In general, for contracts where the holder is receiving a commodity, an increase in the spread (price difference from a benchmark index due to differences in quality or delivery location) or price results in a higher fair value measurement.

Due to the distinctive nature of each of the firm’s level 3 derivatives, the interrelationship of inputs is not necessarily uniform within each product type.

Level 3 Rollforward

The table below presents changes in fair value for all derivatives categorized as level 3 as of the end of the period. In the table below:

 

 

If a derivative was transferred to level 3 during a reporting period, its entire gain or loss for the period is included in level 3. Transfers between levels are reported at the beginning of the reporting period in which they occur.

 

 

Positive amounts for transfers into level 3 and negative amounts for transfers out of level 3 represent net transfers of derivative assets. Negative amounts for transfers into level 3 and positive amounts for transfers out of level 3 represent net transfers of derivative liabilities.

 

 

A derivative with level 1 and/or level 2 inputs is classified in level 3 in its entirety if it has at least one significant level 3 input.

 

 

If there is one significant level 3 input, the entire gain or loss from adjusting only observable inputs (i.e., level 1 and level 2 inputs) is classified as level 3.

 

 

Gains or losses that have been reported in level 3 resulting from changes in level 1 or level 2 inputs are frequently offset by gains or losses attributable to level 1 or level 2 derivatives and/or level 1, level 2 and level 3 cash instruments. As a result, gains/(losses) included in the level 3 rollforward below do not necessarily represent the overall impact on the firm’s results of operations, liquidity or capital resources.

 

 

30   Goldman Sachs September 2016 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Net unrealized gains/(losses) relate to instruments that were still held at period-end.

 

 

For the three months ended September 2016, the net realized and unrealized losses on level 3 derivative assets and liabilities of $154 million (reflecting $17 million of realized gains and $171 million of unrealized losses) include losses of $16 million and $138 million reported in “Market making” and “Other principal transactions,” respectively.

 

 

For the nine months ended September 2016, the net realized and unrealized gains on level 3 derivative assets and liabilities of $510 million (reflecting $110 million of realized losses and $620 million of unrealized gains) include gains/(losses) of $686 million and $(176) million reported in “Market making” and “Other principal transactions,” respectively.

 

For the three months ended September 2015, the net realized and unrealized gains on level 3 derivative assets and liabilities of $869 million (reflecting $22 million of realized losses and $891 million of unrealized gains) include gains of $647 million and $222 million reported in “Market making” and “Other principal transactions,” respectively.

 

 

For the nine months ended September 2015, the net realized and unrealized gains on level 3 derivative assets and liabilities of $1.13 billion (reflecting $158 million of realized gains and $967 million of unrealized gains) include gains of $945 million and $180 million reported in “Market making” and “Other principal transactions,” respectively.

See “Level 3 Rollforward Commentary” below for an explanation of the net unrealized gains/(losses) on level 3 derivative assets and liabilities and the activity related to transfers into and out of level 3.

 

 

    Level 3 Derivative Assets and Liabilities at Fair Value  
$ in millions    

 

 

 

 

Asset/

(liability)

balance,

beginning

of period

  

  

  

  

  

    

 

 

 

Net

realized

gains/

(losses)

  

  

  

  

    

 

 

 

Net

unrealized

gains/

(losses)

  

  

  

  

    Purchases         Sales        Settlements        

 

 

Transfers

into

level 3

  

  

  

    

 

 

Transfers

out of

level 3

  

  

  

    

 

 

 

 

Asset/

(liability)

balance,

end of

period

  

  

  

  

  

Three Months Ended September 2016

                       

Interest rates — net

    $      56         $  (23      $  (48     $  —         $    (2     $     61         $     9         $       1         $     54   
   

Credit — net

    2,942         7         (31     12         (6     (110      101         (4      2,911   
   

Currencies — net

    17         (12      (14     1                39                 1         32   
   

Commodities — net

    (222      (2      (25     1         (4     34         6         210         (2
   

Equities — net

    (363      47         (53     29         (26     (218      3         (122      (703

Total derivatives — net

    $ 2,430         $   17         $(171     $  43         $  (38     $  (194      $ 119         $     86         $2,292   

 

Nine Months Ended September 2016

                       

Interest rates — net

    $   (398      $  (43      $ 129        $    3         $    (5     $     95         $ 304         $    (31      $     54   
   

Credit — net

    2,793         (50      359        68         (38     (393      191         (19      2,911   
   

Currencies — net

    (34      (39      2        15         (4     84         1         7         32   
   

Commodities — net

    (262      22         34        27         (118     12         10         273         (2
   

Equities — net

    (1,604              96        78         (114     824         (6      23         (703

Total derivatives — net

    $    495         $(110      $ 620        $191         $(279     $   622         $ 500         $   253         $2,292   

 

Three Months Ended September 2015

                       

Interest rates — net

    $     (78      $  (27      $     1        $    2         $    (1     $     10         $(112      $       5         $  (200
   

Credit — net

    2,968         39         416        32         (46     109         (5      (219      3,294   
   

Currencies — net

    (149      (18      183        4                37         (4      107         160   
   

Commodities — net

    (54      1         (27     2         (56     (4      7         154         23   
   

Equities — net

    (2,349      (17      318        39         (407     1,513         (88      107         (884

Total derivatives — net

    $    338         $  (22      $ 891        $  79         $(510     $1,665         $(202      $   154         $2,393   

 

Nine Months Ended September 2015

                       

Interest rates — net

    $     (40      $  (10      $    (4     $    5         $  (32     $     31         $(105      $    (45      $  (200
   

Credit — net

    3,530         147         553        56         (151     (700      127         (268      3,294   
   

Currencies — net

    (267      (71      301        31         (8     108         (19      85         160   
   

Commodities — net

    (1,142      9         (68             (87     (95      (20      1,426         23   
   

Equities — net

    (1,375      83         185        105         (694     942         (148      18         (884

Total derivatives — net

    $    706         $ 158         $ 967        $197         $(972     $   286         $(165      $1,216         $2,393   

 

    Goldman Sachs September 2016 Form 10-Q   31


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward Commentary

Three Months Ended September 2016. The net unrealized loss on level 3 derivatives of $171 million for the three months ended September 2016 was primarily attributable to losses on certain equity derivatives reflecting the impact of an increase in equity prices, and losses on certain interest rate derivatives reflecting the impact of a decrease in interest rates.

Transfers into level 3 derivatives during the three months ended September 2016 primarily reflected transfers of certain credit derivative assets from level 2, principally due to unobservable credit spread inputs becoming significant to the net risk of certain portfolios.

Transfers out of level 3 derivatives during the three months ended September 2016 primarily reflected transfers of certain commodity derivative liabilities to level 2, principally due to unobservable volatility inputs no longer being significant to the valuation of these derivatives and transfers of certain equity derivative assets to level 2, primarily due to increased transparency of unobservable correlation and volatility inputs used to value these derivatives.

Nine Months Ended September 2016. The net unrealized gain on level 3 derivatives of $620 million for the nine months ended September 2016 was primarily attributable to gains on certain credit and interest rate derivatives, principally reflecting the impact of a decrease in interest rates.

Transfers into level 3 derivatives during the nine months ended September 2016 primarily reflected transfers of certain interest rate derivative assets from level 2, principally due to reduced transparency of certain unobservable inputs used to value these derivatives, and transfers of certain credit derivative assets from level 2 primarily due to unobservable credit spread inputs becoming significant to the net risk of certain portfolios.

Transfers out of level 3 derivatives during the nine months ended September 2016 primarily reflected transfers of certain commodity derivative liabilities to level 2, principally due to unobservable volatility inputs no longer being significant to the valuation of these derivatives.

Three Months Ended September 2015. The net unrealized gain on level 3 derivatives of $891 million for the three months ended September 2015 was primarily attributable to gains on certain credit derivatives, reflecting the impact of a decrease in interest rates, wider credit spreads, and changes in foreign exchange rates, and gains on certain equity derivatives, reflecting the impact of decreases in global equity prices.

Transfers into level 3 derivatives during the three months ended September 2015 primarily reflected transfers of certain interest rate liabilities from level 2, principally due to certain unobservable inputs becoming significant to the valuation of these derivatives, and transfers of certain equity derivative liabilities from level 2, primarily due to unobservable volatility inputs becoming significant to the valuation of these derivatives.

Transfers out of level 3 derivatives during the three months ended September 2015 primarily reflected transfers of certain commodity derivative liabilities to level 2, principally due to increased transparency of volatility inputs used to value these derivatives, transfers of certain equity derivative liabilities and currency derivative liabilities to level 2, primarily due to certain unobservable inputs no longer being significant to the valuation of these derivatives, and transfers of certain credit derivative assets to level 2, principally due to unobservable credit spread inputs not being significant to the net risk of certain portfolios.

Nine Months Ended September 2015. The net unrealized gain on level 3 derivatives of $967 million for the nine months ended September 2015 was primarily attributable to gains on certain credit derivatives, principally reflecting the impact of wider credit spreads and a decrease in interest rates, and gains on certain currency derivatives, reflecting the impact of changes in foreign exchange rates.

Transfers into level 3 derivatives during the nine months ended September 2015 primarily reflected transfers of certain equity derivative liabilities from level 2, primarily due to reduced transparency of volatility inputs used to value these derivatives, transfers of certain interest rate derivative liabilities from level 2, primarily due to unobservable inputs becoming significant to the valuations of these derivatives, and transfers of certain credit derivative assets from level 2, principally due to unobservable credit spread inputs becoming significant to the valuation of these derivatives.

Transfers out of level 3 derivatives during the nine months ended September 2015 primarily reflected transfers of certain commodity derivative liabilities to level 2, principally due to increased transparency of oil and refined product spread inputs used to value these derivatives, and transfers of certain credit derivative assets to level 2, principally due to unobservable credit spread inputs not being significant to the net risk of certain portfolios.

 

 

32   Goldman Sachs September 2016 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

OTC Derivatives

The table below presents the fair values of OTC derivative assets and liabilities by tenor and major product type.

 

$ in millions    

 

Less than

1 Year

  

  

   

 

1 - 5

Years

  

  

   

 

Greater than

5 Years

  

  

    Total   

As of September 2016

       

Assets

       

Interest rates

    $  6,008        $22,669        $100,614        $129,291   
   

Credit

    1,646        3,264        6,587        11,497   
   

Currencies

    11,981        6,832        9,093        27,906   
   

Commodities

    3,094        2,024        222        5,340   
   

Equities

    3,551        8,478        1,645        13,674   
   

Counterparty netting within tenors

    (3,787     (5,350     (5,114     (14,251

Subtotal

    $22,493        $37,917        $113,047        $173,457   
   

Cross-tenor counterparty netting

          (21,980
   

Cash collateral netting

  

                    (98,608

Total

                            $52,869   

 

Liabilities

       

Interest rates

    $  7,662        $12,921        $  52,702        $  73,285   
   

Credit

    2,513        3,548        2,091        8,152   
   

Currencies

    10,623        7,262        7,107        24,992   
   

Commodities

    2,922        1,351        2,663        6,936   
   

Equities

    4,707        7,070        2,711        14,488   
   

Counterparty netting within tenors

    (3,787     (5,350     (5,114     (14,251

Subtotal

    $24,640        $26,802        $  62,160        $113,602   
   

Cross-tenor counterparty netting

          (21,980
   

Cash collateral netting

  

                    (49,047

Total

                            $  42,575   

 

As of December 2015

       

Assets

       

Interest rates

    $  4,231        $23,278        $  81,401        $108,910   
   

Credit

    1,664        4,547        5,842        12,053   
   

Currencies

    14,646        8,936        6,353        29,935   
   

Commodities

    6,228        3,897        231        10,356   
   

Equities

    4,806        7,091        1,550        13,447   
   

Counterparty netting within tenors

    (3,660     (5,751     (5,270     (14,681

Subtotal

    $27,915        $41,998        $  90,107        $160,020   
   

Cross-tenor counterparty netting

          (20,462
   

Cash collateral netting

  

                    (89,132

Total

                            $  50,426   

 

Liabilities

       

Interest rates

    $  5,323        $13,945        $  35,592        $  54,860   
   

Credit

    1,804        4,704        1,437        7,945   
   

Currencies

    12,378        9,940        10,048        32,366   
   

Commodities

    4,464        3,136        2,526        10,126   
   

Equities

    5,154        5,802        2,994        13,950   
   

Counterparty netting within tenors

    (3,660     (5,751     (5,270     (14,681

Subtotal

    $25,463        $31,776        $  47,327        $104,566   
   

Cross-tenor counterparty netting

          (20,462
   

Cash collateral netting

  

                    (39,950

Total

                            $  44,154   

In the table above:

 

 

Tenor is based on expected duration for mortgage-related credit derivatives and generally on remaining contractual maturity for other derivatives.

 

 

Counterparty netting within the same product type and tenor category is included within such product type and tenor category.

 

 

Counterparty netting across product types within the same tenor category is included in Counterparty netting within tenors. Where the counterparty netting is across tenor categories, the netting is reflected in Cross-tenor counterparty netting.

Credit Derivatives

The firm enters into a broad array of credit derivatives in locations around the world to facilitate client transactions and to manage the credit risk associated with market-making and investing and lending activities. Credit derivatives are actively managed based on the firm’s net risk position.

Credit derivatives are individually negotiated contracts and can have various settlement and payment conventions. Credit events include failure to pay, bankruptcy, acceleration of indebtedness, restructuring, repudiation and dissolution of the reference entity.

The firm enters into the following types of credit derivatives:

 

 

Credit Default Swaps. Single-name credit default swaps protect the buyer against the loss of principal on one or more bonds, loans or mortgages (reference obligations) in the event the issuer (reference entity) of the reference obligations suffers a credit event. The buyer of protection pays an initial or periodic premium to the seller and receives protection for the period of the contract. If there is no credit event, as defined in the contract, the seller of protection makes no payments to the buyer of protection. However, if a credit event occurs, the seller of protection is required to make a payment to the buyer of protection, which is calculated in accordance with the terms of the contract.

 

 

Credit Options. In a credit option, the option writer assumes the obligation to purchase or sell a reference obligation at a specified price or credit spread. The option purchaser buys the right, but does not assume the obligation, to sell the reference obligation to, or purchase it from, the option writer. The payments on credit options depend either on a particular credit spread or the price of the reference obligation.

 

 

    Goldman Sachs September 2016 Form 10-Q   33


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Credit Indices, Baskets and Tranches. Credit derivatives may reference a basket of single-name credit default swaps or a broad-based index. If a credit event occurs in one of the underlying reference obligations, the protection seller pays the protection buyer. The payment is typically a pro-rata portion of the transaction’s total notional amount based on the underlying defaulted reference obligation. In certain transactions, the credit risk of a basket or index is separated into various portions (tranches), each having different levels of subordination. The most junior tranches cover initial defaults and once losses exceed the notional amount of these junior tranches, any excess loss is covered by the next most senior tranche in the capital structure.

 

 

Total Return Swaps. A total return swap transfers the risks relating to economic performance of a reference obligation from the protection buyer to the protection seller. Typically, the protection buyer receives from the protection seller a floating rate of interest and protection against any reduction in fair value of the reference obligation, and in return the protection seller receives the cash flows associated with the reference obligation, plus any increase in the fair value of the reference obligation.

The firm economically hedges its exposure to written credit derivatives primarily by entering into offsetting purchased credit derivatives with identical underliers. Substantially all of the firm’s purchased credit derivative transactions are with financial institutions and are subject to stringent collateral thresholds. In addition, upon the occurrence of a specified trigger event, the firm may take possession of the reference obligations underlying a particular written credit derivative, and consequently may, upon liquidation of the reference obligations, recover amounts on the underlying reference obligations in the event of default.

As of September 2016, written and purchased credit derivatives had total gross notional amounts of $798.19 billion and $840.18 billion, respectively, for total net notional purchased protection of $41.99 billion. As of December 2015, written and purchased credit derivatives had total gross notional amounts of $923.48 billion and $968.68 billion, respectively, for total net notional purchased protection of $45.20 billion. Substantially all of the firm’s written and purchased credit derivatives are credit default swaps.

The table below presents certain information about credit derivatives.

 

    Credit Spread on Underlier (basis points)  
$ in millions     0 - 250        

 

251 -

500

  

  

   

 

501 -

1,000

  

  

   

 

Greater than

1,000

  

  

    Total   

As of September 2016

          

 

Maximum Payout/Notional Amount of Written Credit Derivatives by Tenor

  

Less than 1 year

    $228,332         $  6,064        $  2,188        $   8,167        $244,751   
   

1 – 5 years

    407,671         19,029        10,016        12,324        449,040   
   

Greater than 5 years

    90,292         9,836        2,831        1,444        104,403   

Total

    $726,295         $34,929        $15,035        $ 21,935        $798,194   

Maximum Payout/Notional Amount of Purchased Credit Derivatives

  

Offsetting

    $631,589         $26,543        $14,590        $ 19,321